Credit Modeling 101 - How do I get an 800 credit score?
There is a lot of false information out there for anyone considering the facts about credit scoring/modeling. Much of this information is perpetrated by the so called ‘credit repair industry’ which is mainly a scam or waste of money. Why pay someone good money to do something that you can easily do yourself? Keep in mind: there is no quick-fix to turn bad credit into good credit, but a well informed consumer could manage their credit easily and with a little diligence build better credit for the long term.
The “Big 3” bureaus (TransUnion, Experian, Equifax) all have different proprietary models that they use to determine your credit-worthiness when you apply for a loan. Being employed in the financial world, I’ve come across the good, the bad and the ugly on everything from mortgage applications to lines of credit. And surprisingly, it all boils down to a few criteria that can make or break your credit score.
These four criteria are really pretty simple – and if you think about it, they make sense. Please note: the following it is a gross oversimplification of the models that the big bureaus use and is meant to give a general understanding of how credit-worthiness is determined.
1- Credit Length or Credit Depth
This is how long you have had open ‘trade lines’ (fancy term in the biz to reference open lines of credit). A borrower with a long established credit history has less inherent risk than someone with no established credit history. Those of you who are fresh out of college with no debt can attest to this. It is very difficult for you to obtain financing with no established credit history. The old saying is that “no credit is worse than bad credit” is pretty much true. Many lenders out there will lend to high risk individuals over an unknown risk, since they know the default rates for a person with certain risk criteria vs. no criteria. This is one aspect of how your interest rate is “calculated.”
2- Credit Diversity
Credit diversity is how “diversified” your portfolio of debt is. Do you have a mortgage? Do you have an installment loan (auto loan or some money borrowed on a fixed term to repay)? Do you have revolving accounts (open lines of credit that have no fixed term to repay, like credit cards and personal loans)? A person with debt in three of these categories is considered greatly diversified. The lender views this as your potential to juggle these categories. And to do this adequately, you must be responsible with your bills and have your budget in line.
3- Payment History
Yes, you guessed it… Payment history is how timely you have made your payments! This can be a little tricky, as some credit cards will setup billing from the time you activate the card, rather than 1st, 15th or end of the month, thus leading to inconvenient billing at odd times of the month. There is also a “grace period” to consider. A grace period is a specific amount of days that you have after your closing date to get your payment in without being docked a late penalty (and having a 1×30 late reported to the bureaus). Some credit cards have zero days of grace period. Please refer to the contract or brochure that your credit cards come with to see if you have a grace period. These little items are very important to read through as they legally obligate you to the terms in which you are borrowing this money. Late payments are a HUGE negative on your credit. I’ll enlighten everyone later on the process of derogatory credit obligations, the process they take and even disputing them.
Ok, so we are almost to the last item to get you to that elusive 800 credit score. We are an individual who has a credit card, auto loan or fixed term short duration payoff and a mortgage. We make all our payments on time… Great! However, we need one more item to make lenders line up to give us money:
4- Credit Utilization
Credit Utilization is how much you have used or utilized on your outstanding credit balances. This model affects your credit score via your is credit cards. If a bank sees that you are 100% utilized on all your credit, then you are essentially at the “end of your rope.” Banks know that the next time your car breaks down, your kids need hospital treatment or an unexpected expense arises, then you will probably make a late payment. This is a BAD thing! I cannot stress enough how poorly maxing out your credit cards affects your credit score. The general rule of thumb is to remain under ONE THIRD of the utilization on your cards. The “Big 3” will actually ‘ding’ your credit score negatively (each with increasing weight) the more you put on a card over that 30% balance. They have dings for each level at 50% 75% 90% and 100%. If you have a clean payment history and for whatever reason, just max out the cards, you would have found that this does indeed NEGATIVELY affect your credit.
Well boys and girls, if you have these four simple rules in your mind every time you reach for that AMEX or VISA, then you will be on top of your finances and your spending. These few simple rules will force you to think of your utilization and allow you to proactively avoid maxing out your credit cards. It will also put you at the lowest burden of interest since your credit will be stellar. I hope you enjoyed this article and feel free to contact me with any credit related questions!
References:
(1) Equifax credit modeling guidelines: http://www.myfico.com/Downloads/Files/myFICO_UYFS_Booklet.pdf
(2) Experian credit modeling guidelines: http://www.vantagescore.experian.com/factors.html
(3) Transunion credit scoring criteria: http://www.truecredit.com/help/learnCenter/creditScores/creditScoring101.jsp?cb=TransUnion
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