Belcaro RE Trends: Improving Credit

How can you improve your FICO score?

To improve one's credit score, it's critical to understand the factors influencing a credit score.  The factors that contribute to a FICO score and the weighted percentages for each are as follows:

• 35% - timeliness of payments
• 30% - the ratio of used debt to allowable debt for consumer credit
• 15% - length of credit history (the more credit history and showing proof of consistent timely payment, the better the score)
• 10% - types of credit used 
• 10% - recent credit inquiries and recent new credit

The greatest driver behind a score is making timely payments on all accounts.  Scores will be adversely affected for any payment that is 30 days late or more.  Being late on a mortgage payment will not only crush one's score, but will also make qualifying for a new home loan extremely challenging.  Collections and past due accounts are obviously bad; however, paying off old collections can actually hurt FICOs in the short term.  Many collections report from years past.  If that collection is paid off, the account activity date is brought current, which could initially drive down the score. 

A common misconception is that having one's credit pulled is the worst thing you can do to your scores.  While it's wise to keep credit pulls to a minimum, keeping the proportion of monthly debt to allowable debt at low ratios is far more critical in improving one's score.  For example, if a borrower has a credit card with a maximum limit of $15,000 and they owe $14,000, the proportion is almost 100% and the borrower is close to being maxed out.  Getting the ratio below 50% would help and below 35% would be optimal.  For revolving debt, I recommend borrowers contacting their credit card companies every six months to request increased maximum limits.  It is vital not to use this new allowable debt, rather, use it as a means to always keep the proportions in check.  Additionally, many borrowers will spread out their credit debt over a few cards to keep the ratios below 35% on all of the cards.  Or, if liquid funds are available, it could make sense to pay down the debt.

Another method of improving FICOs is to establish credit history over prolonged periods of time.  By doing so, the scoring formula treats longer credit history as a means of proving that a borrower can be extended credit, but do not put themselves into a compromising situation.  Many borrowers will keep inactive credit cards open, instead of closing them, in order to increase credit history.  Most lenders like to see at least four lines of credit on a report (called tradelines) that are open with at least two years of history.  Of these tradelines, it's ideal to have balance between the types of accounts: mortgages, installment loans, revolving debt. Too much revolving debt, such as credit cards, can adversely impact scores as it can make the borrower to appear to be over-extending themselves.