Why Credit Scores are Like Pieces of a Pie

A Consumer’s credit score is used as a risk factor for vendors to determine the chances of a borrower to receive a 90 days late in the next 24 month.  There are over 40 factors/reasons that go into determining a credit score.  And, it’s all about the percentages.

Think about a pie.  It’s usually cut into 6 or 8 equal pieces, right?  Each person’s credit score is divided up like pieces of pie, but the difference is that the pieces are NOT equal.

Credit Score determination are generally broken down in the following percentages:

1. Payment History – 35%

Recent (how recently did the later payment happen), Frequency and Severity

0-6 month is the most severe; 7-24 month not as sever; over 24 month less sever

2. Balance – 30%

High Balances on revolving credit is more severe than on installment account.  Credit reporting agencies look at cumulative totals.  Limits charged up over 75% of the available credit are More Severe. Therefore, it is not always better to go close out account with no balance on them.  Spread out balance if possible – small balances on multiple credit cards is better than one maxed out credit card.

Home Equity Lines – Not as volatile as credit cards. They are treated as a revolving line unless the amount is greater than $30,000.  When the balance is over $30,000, equity lines are treated as installment debt.

Special Note on American Express:  American Express will report previous month balance if no current balance is show.  Always check American Express reporting because it can be reported as being “Maxed Out”.

3. Credit History – 15%

A Trade line between 3-5 is ideal.  The longer the credit history, the lower the risk.

4. Type of Credit – 10%

The number of trade lines is counted for the present and the past.

Special Note:  Finance companies – like furniture and appliances store “buy now and pay later” credit can have one of the most adverse effects on credit.  They are considered higher risk. Having too many finance company accounts can hurt the credit score.

5. Inquiries – 10%

Each inquiry can cost 5-15 points off your credit score.  5-7 inquires per 12 month period should be the limit.  There are limited numbers of inquiry dings per year the credit reporting bureaus will give you. It is not infinite.

• Finance company inquires have the most adverse effect
• Promotional inquires – where companies look at your credit to pre-approve you for credit – does not affect the score unless you accept the offer.
• Multiple-Mortgage related inquires – if done in the 14 day period will not have an adverse effect.

Public Records:  Bankruptcy and any public records can put you in a different risk group.

Bankruptcy:  The credit bureaus look at recently and percentage of trade lines included in bankruptcy. What has the performance been since the bankruptcy? Any lates can be looked at as a risk for repeat of the pattern.

Collections:  It is not necessarily good to pay off collections before applying for a home loan.  Paid or unpaid is still a negative. Paying shows a recently and could lower the score instead of improving it.  The best option is to get a letter from the collection agency (not the original creditor) explaining that it was reported in error.

Instead of filing Bankruptcy, some consumer goes through a Consumer Credit Counseling Service or Debt Reduction Service to reduce the outstanding balance and debt on each account and then combine it all into one monthly payment.  The conforming mortgage lenders often consider this just like they would a Chapter 13 Bankruptcy.  So be careful!

Divorce Settlements: They don’t automatically show up to the credit report. Consumers will still appear to owe that debt even if it was assigned by a judge to the other spouse. Consumers do have the rights now to provide a letter of explanation to the bureaus.

Why Credit Scores are Like Pieces of a Pie