FINANCIAL FREEDOM - Understanding Credit Scores
Financial Freedom
Understanding Credit Scores
Let’s face it, unless you are starting your adult life with a well-endowed trust fund you will find yourself at some point in need of obtaining financing. Business financing for starting capital or expansion capital is almost a given and in today’s world and market personal guarantees are a requirement leading to the presentation of your credit score. On a personal note, it will be that first financed car or home. Even when renting an apartment, credit scores are considered as part of your application. It also affects your home and auto insurance rates. For certain jobs, especially in finance, credit scores also can be the final factor in what lands you the job or makes you ineligible. Forensic Internal Audit Inc. has decades of experience analyzing and understanding how credit score systems work and assisted numerous individuals in regaining their financial health. Credit Scores is the first section of our Financial Freedom course.
A credit score is a statistical method to gauge your credit worthiness, control risk management for the lender or applied to party and basically shows the likelihood of an individual’s ability to repay their debt. A credit score may also be referred to as a FICO score. FICO is an acronym for the Fair Isaac Corporation, the creators of the FICO score which opened in 1956 and released its general purpose scoring “FICO” in 1989. Today, there are multiple scoring systems and three main reporting bureaus that lenders use: Experian, Equifax and Trans Union. Because each bureau uses slightly different systems to calculate you can have a different score with each. Experian and Trans Union use two different types of FICO systems while Equifax uses a system called Pinnacle. The following are the 5 main components of the credit score and ways to manage them.
1. PAYMENT HISTORY 35%
The number one factor in all credit score models is payment history. Nothing is more detrimental than a derogatory mark such as accounts in collection, foreclosure, liens and bankruptcy. The second highly detrimental factor is late payments. The most painful part of late payments and derogatory marks on your credit report is that it takes 7 years to clear from your credit score. Don’t give up hope. Forensic Internal Audit Inc. can help by walking you through a foreclosure, a bankruptcy and then the new life of rebuilding your credit. We have personally led a client from a 580 credit score to a 665 credit score in only 9 months from date of bankruptcy discharge. Sometimes, however, bankruptcy is your best option for financial freedom if you now have a severe payment history. Forensic Internal Audit Inc. can help you determine which path to take and the guidance to regain control of your financial future.
2. UTILIZATION 30%
This represents the amount of credit used compared to the overall credit limit. The number one false concept we hear at Forensic Internal Audit Inc. is how a client will max out a card then pay it off every month. Depending on the card cycle, this can have a highly negative effect on your score. The utilization method is broken down into percentages as well. The “Excellent” category is when you utilize less than 10% of your credit availability. Translated, if you have a credit card with a $1000 limit you do not want to exceed a $99 balance on it. This is the fastest way to build your credit score. Another huge misconception is to pay off a credit card and close it. Never close a credit card unless it has a yearly fee attached, just don’t use it. The reason is the calculation is based on all credit cards combined. So if you have a $1,000 limit credit card with a high interest rate and a $1,000 credit card with a low interest rate your total credit limit is $2,000. You then can use up to $199 on the low interest card and still have a less than 10% utilization rate. Utilization of 10% - 29% is still rated as good and will help your credit grow so you really need to strive for fewer than 30% utilization combined as a maximum. 30% - 49% is fair and has no impact on your score. 50% - 74% is Poor and this is where you start losing points, 75% + is completely detrimental, thus, do not max out your cards then pay off monthly. If your credit card company is not increasing your limit every 6 - 12 months then call and request this to improve your utilization. Also keep in mind, applying for new credit will initially lower your credit score via “hard credit check” average about 3 points so make sure you do this low and slow over time.
3. LENGTH OF CREDIT HISTORY 15%
Starting your credit history early is vital. Helping your children manage a gas card or emergency card straight out of high school is what we advise our clients. Having no credit history equates to a low credit score. Granted, to start out you may need to use a secured card where as you pay a bank or other institution $1000 as security and they issue a $1000 credit card. This often has no interest or low interest attached and the purpose is to help you build your credit. Depending on where your credit score is at, you should be able to get a non-secured card within 3 – 9 months.
4. CREDIT MIX IN USE 10%
All credit venues are not scored equally and showing a good mix is helpful. These venues are divided into two categories, Revolving Credit and Installment Loans. The former is comprised of retail accounts and credit cards while the later includes Mortgage, Auto and Student loans. The exact “best” mix is unknown and will be discussed in the conclusion, however, Forensic Internal Audit Inc. as with many other financial organizations have come up with good assumptions and guidelines. Credit Cards are essential for credit utilization ratios. Installment loans, particularly mortgage loans are collateralized by the asset itself as well as a liquidity factor of the positive equity. Student Loans also show collateralization if guaranteed by a government entity a pro but also are not dischargeable in a bankruptcy (because they are in first place over any other lenders position) a con. It is probable that Revolving lines with an “excellent” utilization along with positive equity mortgage loans are key in your strategy mix.
5. NEW CREDIT 10%
This goes back to the previous comment about going “Low and Slow” and also reflects on an item that is used by other authorizes as the number 6 on their list and also previously mentioned “hard credit check”. Opening multiple credit sources all at once is not helpful. Yes, it can help with a good utilization percentage but within these measurement systems you can teeter into a danger zone of risk management. Another finding Forensic Internal Audit Inc. has pertaining to the secret recipe of the credit scoring systems is this: Your income is back fed into the credit score system by every revolving or installment account you apply for, knowing when you are getting in over your head therefore is also known. Going low and slow shows the lending authority you are in charge of your finances and are low risk.
These main points are the skeleton to get you started with a healthy and “lendable” financial future. Forensic Internal Audit Inc. can help you with the muscle and skin of this highly important endeavor. Although the exact formula of the credit scoring systems stated above is secret as it proprietary information of the creators, financial experts such as Forensic Internal Audit Inc. have the experience to successfully guide you. Strive to never make late payments and keep your revolving credit line utilization under 10%. Starting your credit history as soon as possible is important and should be done as soon as you graduate from high school. A secured credit card is an easy starting point. Positioning a proper credit mix is important and remember low and slow works best and should be based on your income.
Understanding credit scores is the first section of a full spectrum course titled “Financial Freedom” offered by Forensic Internal Audit Inc. Other topics include personal and business Balance Sheets and Income Statements, understanding cash flow and budgets, applying for personal and SBA loans, and understanding investments and passive income. We also work one on one with personalized focus and offer other financial services such as bankruptcy assistance and recovery after a foreclosure. Please visit our website at www.fiainc.net and feel free to contact us at info@fiainc.net.
