I’ve written before about the history of credit cards.  Here’s a satirical take on the industry from The Comedy Channel’s Colbert Report.

As credit cards balances get close to their maximum limits, your score will start to drop. In fact, a single credit card at its maximum limit can lower someone’s credit score by 75-100 points.  This drop in a score can be the difference between a mortgage loan approval or denial, or add 2% to the interest rate on a car loan.

Reducing the amount owed on a credit card is the fastest way to increase your score.  Even using 20% of the limit of a card ($2,000 with a limit of $10,000) can start to have an impact on your credit score.

Consolidating credit card balances onto one low interest rate card can save you money on credit card interest. However, if this also maxes out the limit on the low interest rate card, you will lower your credit score.  Save the money on the credit card interest only if you are not going to be using your credit score to qualify for something more important. That is, don’t try to save $50 on credit card interest and increase your mortgage payment by $300 due to a lower credit score.

How can you lower your balances and credit utilization ratios?

1. Don’t spend too much – imagine how things would look if Congress and the White House had to have the money to spend it?  You and I should know that, so we also need to live that way.  Credit cards are ok to use to get frequent flier miles, but if they are never not paid in full at the end of the cycle – they are a problem, not a solution. Quit spending more than you can pay each month!
2. Pay off your credit cards every time you get paid.  If you get paid bi-weekly, pay your credit cards online the day you get paid.  This way your balance is always low and manageable, and you never get tempted to carry over the balance from one month to the next.  The best savings accounts today yield only 0.25% to 1.5%, so don’t risk paying interest on credit cards in the hope that you will earn an extra $0.99 on your savings account while waiting to pay off your credit cards.
3. Call your established credit card accounts and ask them to increase your credit limits.  This won’t pay down the balance but it will reduce the amount owed ratio and help your score.  Many banks won’t do this anymore, but if you don’t ask, the answer is definitely ‘No’.  Ask.
4. Don’t do the balance transfers. Most people don’t read the fine print on the transfer and credit card lenders will stick you with a 3% balance transfer fee.  On a home loan, no one would pay 3 points to get a lower rate, but people do this routinely on credit card balance transfers. Balance transfers will usually leave you with a maxed out credit card and still cost you money.
5. Steamroll your credit cards.  Pick the card that is closest to its limit, and apply all extra cash to paying off that card.  When it gets to zero, take that cash and steamroll onto the next card.  Usually we use this strategy to get out of debt, but if the goal is to increase the credit score, rank order your cards in terms of how close you are to the limit rather than the actual interest rates. As each card is paid off, you will have more and more cash available to apply to the next account.  Pay off cards prior to other loans as loan accounts won’t impact your credit score as much as credit cards.

Keep Credit Card balances low.  Reducing what you owe on credit cards can increase your score by up to 80 points in as little as 30 days.

You need to get your credit score to at least 740 in today’s economy.

If your credit score is not a 740 or higher, you will pay more for things like home loans, auto loans, credit cards, insurance. The extra costs of all these things will make it very difficult to have extra money left over.  A lower credit score is like a stealth tax that takes away your ability to save more, spend less, and possibly, even earn more.

The main reasons people have lower than a 740 credit score:

1. High balances on credit cards
2. Late payments
3. Collection accounts from old medical claims
4. Collection accounts from utility bills that their college roommate was supposed to pay
5. Not establishing credit

Ongoing things to do:

• Keep your credit card balances as low as you can
• Keep your credit limits high – don’t close accounts, and don’t lower your limits
• Pay your bills on time

If you have old collection accounts, touching them is going to hurt your credit.  If you aren’t planning any major borrowing in the next year, let’s go ahead and clean them up.  Paying off an old collection account will not immediately improve your score, in fact, your score will likely drop for a few months.  The credit scoring model treats recent derogatory credit more harshly than old stuff.  So, if you pay off a collection, it makes it appear recent and brings down your score.

Even if “it’s not your fault”, paying a collection that your old insurance company or roommate was supposed to pay, is far better in the long run than being right.  Take the hit, write the check, and over time, that old collection will fade from memory, and more importantly, from your credit report.

If you are thinking of buying a house or car this year – don’t touch old collection accounts! Stirring up the past will lower your score and will cost you more to borrow.  Make the important purchases first, then go back and clean up the old stuff on your credit.

When people tell me they “are working on their credit”, I usually wince, as what they are doing is hurting them.  People normally close accounts (Bad), pay off old collections (bad), and lower limits on existing credit cards (bad).  If you need to “work on your credit, have a mortgage professional who understands the credit scoring model help you create a plan for success.  Call me if you want to talk it over and don’t have someone else to work with.

When you got a copy of your credit report (www.annualcreditreport.com) last week, I asked you to count your tradelines.  If you didn’t get your credit report yet, read this post first on how & why.  If you have been using credit for more than 10 years and have no late payments, you are at a place where you likely want to start using less credit.

The people I see with 800+ credit scores will have  a very good, long credit history, with never a late payment, collection account, or bad debt, and they will have very few active accounts.

• Pick 2 credit cards to keep open – usually Visa, MasterCard, or American Express, not department store or gasoline cards.  Pick the cards with the longest time open as well.

  

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Closing the other cards will not impact your score as you have a strong credit history.  If you have any blemishes on your report – skip this step!  It’s only to help someone go from really good credit score to outstanding, like  a 760 to an 800.

• Never miss a payment date.  In fact, I usually pay off both my cards in full every two weeks when I get paid to never let the balance get high.  You have to keep balances extremely low – like 10-20% of the maximum limit to have an 800 score.

• Stop new offers from coming in.  Visit www.Optoutprescreen.com to have your information blocked from credit card offers. This reduces the chances of fraud, identity theft, and new inquiries on your credit report.

Ideally, to get an 800 plus credit score you will have:

• Mortgage Loan
• 2nd Mortgage (Optional if needed)
• Auto Loan
• 2-3 Credit Cards that have been open for many year with very low balances

In my next post, I will show ways to get to a 740 FICO if you aren’t there yet.

I am offering a complimentary review of credit this month – if you want me to look over your report, email me for more information on this free, no obligation offer.

Know what you are working with!

If you haven’t seen your credit report in a while, get a copy now.  There is only one place for a truly ‘Free’ report – but it comes with a catch – www.AnnualCreditReport.com will give you a copy, but the catch is you have to pay for your score.  At this point, you don’t really need the score, but you can pay the extra money if you want to.

Other services (with catchy radio jingles) offer free reports, then try to sell you their service.  Use with caution.

When you get your report, you need to decide if you are in one of two camps:

1. I don’t have enough credit and need more credit history
2. I have very established credit history, and too much credit.

Your credit score will usually reflect the categories above – if you are below a 720-740 range, you need more or better credit history.  If you are above a 750, your score won’t improve further with more credit accounts, in fact, you probably have too many accounts to keep your score from getting even higher.

Credit scores range from 350-850

The lowest I’ve ever seen is in the 400′s, and I routinely see credit scores in the 800-810 range.  Above 820 is just luck.

What Score do you need?

• To buy a house with an FHA loan: 620 (Although the FHA says 580 officially)
• To buy a car:  700
• For a Jumbo Mortgage:  680-720
• Best rates on a Conforming mortgages: 740

Above a 740, credit scores are really just bragging rights, but the higher the score is, the more buffer you have in case something happens to your score. If you have an 810, for example, and a credit card payment gets lost in the mail, the late score won’t affect your home mortgage rate. However, if you have a 741, and then make a late payment, you will drop below 740, and then your mortgage rate would be higher.

Step One:

After getting a copy of your credit report – count the number of active “tradelines”, or active accounts that are on your report.

• More than 4 tradelines:  We’ll probably close some of them down.
• 4 or fewer tradelines: You will want to get some new credit.

Check back in a few days after you get your credit report copy and we’ll talk specific strategies for both groups.

I’ve decided that February is going to be Credit Score Improvement Month here at StartwiththeHouse.com and in Charlotte, NC. All this month, I am going to be posting tips and articles on specific things you can do to improve your credit score.

Why work on improving your credit score?

Your credit score impacts so many areas of your life.  My belief is that it is almost impossible to succeed financially today with a low credit score as the cost of bad credit is too much to overcome, short of winning the lottery.  Your credit score can impact:

• Mortgage rates
• Car loans
• Cell Phone plans
• Employment
• Medical Treatment
• Security Clearances
• Credit Cards
• Equity Lines

There are a lot of ‘Myth-conceptions’ about credit scores.  In fact, I still wince every time someone tells me “I am working on my credit score” as this usually means that what they are doing is exactly the opposite of what they should be doing to improve their score.

Several years ago, Sarah drove home this point.  Her idea of working on her credit, was to close all the accounts she no longer used.  Problem was, she didn’t use any credit cards, so she closed every account she had.  The end result was that her 728 credit score dropped to a 635 in less than a month.  Sarah was still able to buy a home, but the lowering of her score almost prevented that from happening.

Check back often this month, or subscribe to the RSS feed of this blog to learn more – I’ll be posting several articles this month with specific things you can do to raise your score starting this month.

1.       Do you pay your bills on time? The answer to this question is very important. If you have paid bills late, have had an account referred to a collection agency, or have ever declared bankruptcy, this history will show up in your credit report.

2.       What is your outstanding debt? If the amount you owe is close to your credit limit, it is likely to have a negative effect on your score.

• Keeping your credit cards balances at 20-30% of their limit is the fastest way to increase your credit score.

3.       How long is your credit history? A short credit history may have a negative effect on your score, but a short history can be offset by other factors, such as timely payments and low balances.

• Parents, help your children establish good credit habits – not using credit at all will hurt them as they get older and want to buy a house, so help them get credit when they turn 18, and then make sure they treat it with respect.

4.       Have you applied for new credit recently? If you have applied for too many new accounts recently that may negatively affect your score.

• The 10% you saved at a department store last month by opening a new account can lower your score.  If your score lowers just prior to buying a house or getting an auto loan, that 10% store savings is nothing compared to the cost of a lower credit score.

5.       How many and what types of credit accounts do you have? Many credit-scoring models consider the number and type of credit accounts you have. A mix of installment loans and credit cards may improve your score.

• When I see credit scores above 800, the owner of that score will never have more than two credit cards, one mortgage, and maybe a car loan.  To get an 800 credit score, you need to have used credit in the past, but now only use 1 credit card, pay if off every month, and close all the accounts you don’t use.
• Closing accounts is normally bas for your credit.  If you have a score below 720, this is usually true.  When you get a score above 750, closing old accounts will further increase your score.

Keeping your credit score above 740 is necessary in today’s economy. People with lower credit scores will pay more for home loans, car loans, cell phones, and it can even effect employment hiring, auto insurance and home owner’s insurance rates.

Here is a list of ten things you should consider doing in 2010 to get on better footing financially this year:

1. Build an Emergency Fund
2. Pay off any debts that aren’t increasing your wealth
3. Make sure you have the right insurances in place
4. Re-balance all your assets – make sure your money is where you want it to be
5. Review your mortgage
6. Buy an Investment Property or Help Someone buy their first home
7. Increase your 401k or IRA savings
8. Save for your kids College Education
9. Buy the home you really want (Prior to April 30th)
10. Buy your retirement home now, and then rent it until you need it.

1. Build an Emergency Fund.  Read more here and here.  Be ready to handle life surprises – an emergency fund is what you will use in 2010 if you don’t have 365 consecutive great days this year.

2.  Pay off debts that aren’t increasing your wealth.  A mortgage allows you to 1. own a house and 2. have you money somewhere else besides inside your house.  Credit Card interest, car loans, and student loans prevent you from saving money for the future.  When the interest expense is gone, your net income (money left at the end of the month) goes up – so you have more money to spend or save.

3.  Make sure you have the right insurance.  As part of the previously mentioned 365 consecutive great days, make sure you are covered if you get sick, hurt, or someone sues you. (Or if something really bad happens).  Review your insurance needs with an insurance professional – shoot me an email if you need a few good names of people you can call.