I make my payments on time. Why do I have a low credit score?

This question is asked often when I have people apply for a new mortgage and with good reason. You might believe that if your payments were made on time that should give you at minimum, a good credt score.

Not Always True!

Credit scores are composed of multiple pictures of your financial health and then rated on your "credit report", while making payments on time is VERY IMPORTANT, these other factors can improve or worsen your scores as well. Read on.....

There are several reasons a credit score may be low even if the payments are on time, but I will write about the most common cause that I have seen by doing a comparison of 2 families.

Example:

Client A: Has a 150K mortgage that has been paid on time since the home was purchased 4 years ago.   

An Automobile payment of 260.00 per month paid on time since it was purchased 3 years ago

4 credit cards all paid on time(all over 2 years old). 

Card 1 Balance= 250.00      Credit Limit= 5000.00

Card 2 Balance= 199.00      Credit Limit= 2500.00

Card 3 Balance= 125.00      Credit Limit= 4,000.00

Card 4 Balance= 900.00      Credit Limit= 10,000.00

                                                                     VS

Client B: Has a 140K mortgage that has bee paid on time since the home was purchased 3.5 years ago.

An Automobile payment of 301.00 per month, paid on time since it was purchased over 2 years ago.

5 credit cards all paid on time(all over 2 years old).

Card 1 Balance= 2485.00      Credit Limit= 2500.00

Card 2 Balance= 910.00        Credit Limit= 1000.00

Card 3 Balance= 4,600.00      Credit Limit= 5000.00

Card 4 Balance= 1325.00       Credit Limit= 1500.00

Card 5 Balance= 792.00         Credit Limit= 750.00

As shown the primary difference between Clent A & B is the ratio of used credit(Balance) to available credit(Credit Limit).

While client A has kept their balance low(under20%), client B maintains a high balance of over 90%. On card 5 they are over 100%!

The result in this example is that client A has a 760 credit score and client B has 629 credit score. This is due to the fact that when a revolving debt account has a decreasing available balance, the credit reporting system sees it has a sign of financial stress, therefore a higher credit risk is assigned to that report, resulting in the lower score for client B

It is also important to mention that should a collection or a late payment appear on either one of these clients reports, it is client B that would be most adversly affected(easily could push their score to below 620) due to their high debt ratio on their credit cards.

The cure for client B is to start paying down their credit cards with the smallest balances first, and to keep their balances under 40% of their available credit limit on average.

Today it has become even more important to maintain a higher  credit score as both FHA & Conventional mortgages have moved to the "Risked Based Pricing Model" which rewards with lower interest rates for higher credit scores, saving you money.