Credit Scoring Explained – Part 5 of 5

The last credit scoring factor, which is credit inquiries and new accounts, gets more attention than it should, especially when considering that it only makes up 10% of your score. I would guess this is because it is fairly easy to understand and control.

The fact of the matter is that if you don’t apply for new credit, you won’t have any inquiries or new accounts. But there is more to it than that. Here are some more details.

There are two types of inquiries, hard and soft. Hard inquiries are when you have applied for a new account and the creditor pulls your credit. Soft inquiries are when your credit is pulled and the purpose is not for the purpose of extending credit.

Examples of this are when you pull your own credit, a potential employer checks your credit or when a creditor checks scores to decide whether to send you a pre-qualified offer, which does not mean that you are approved. It only means that you have met certain requirements for them to ask you to apply for credit with them.

Hard inquiries can affect your score but soft inquiries do not. And hard inquiries only count against your score for one year. They stay on your report for two years but after one year, they have no effect on your score, no matter how many there are.

In fact, after 6 months, as long as there aren’t more of them, inquiries have much less effect on your score.

Another thing you should know is that on mortgages, car loans and student loan applications, it is expected that someone could have their credit pulled more than once. When you apply for a mortgage with a broker, even if you aren’t shopping around, your credit is going to be pulled at least twice, once by the broker and once by the lender they send your file to.

When you apply for a car loan at a dealership, it is not uncommon for them to pull your credit then send it out to several other lenders to see who will give you the best terms.

How would you feel if you knew your credit was going to be pulled 5 times for every dealership you went to and that every time someone pulled your credit, the score would go down? You wouldn’t want to go car shopping, would you? Neither would I.

And most people think this is exactly what happens. Fortunately, it isn’t true.

Credit scoring models used today take this into account. Any inquiries for a car loan within a “short period of time” are counted as a single inquiry. The same thing holds true for mortgages and student loans.

The definition of a “short period of time” depends on whether the lender is using new or old scoring models. If they are using the older models, it is 14 days and with the newer models, it is 45 days. The older models give you less time to shop than the new models but 14 days is still usually enough time to choose a lender for any of these purposes.

Even if it isn’t, you can still do quite a bit of shopping within 14 days and then choose a lender and have your credit pulled once more if necessary.

Even though inquiries and new accounts only account for 10% of your score, it is still a good idea to manage them and make sure you only apply for new credit when you need it. Doing your homework to find out what you really qualify for also helps to avoid unnecessary inquiries.

And opening new accounts you don’t need can reduce your score, even if only a little bit. An example is when you are paying for something at checkout and they tell you that if you apply for an account with them that you can save 10% off that purchase.

For more information about credit, you can find my book, Crack The Credit Code, To Play The Game, You Need To Know The Rules which is available on Amazon. Or, go to my website, CrackMyCredit.com.

How Many People Have Bad Credit?

If you were to do a search online to find out the average credit score in the United States, you would find that it is about 700. And if you work with credit reports, you might be surprised by that number, probably thinking it is too high.

And if you did, you would be right. Here’s why.

As of April 4, 2020 the US Census Bureau estimated the US Population at about 329 million people with about 254 million adults.

Experian says that 33% of these adults have bad credit, which is anything below a 670 score. That comes out to 84 million people with bad credit. But they are not counting another large group of people. The group I am talking about includes those who have no credit score at all.

This group is estimated at 50 million people. Since they have no score at all, they are not included in the calculation of the average credit score. They are not being counted at all.

But if you combine these people with the 86 million who have bad credit, the total number of people who have bad credit or no credit comes to 136 million people. This is almost 53% of the adults in the United States.

In other words, more than half the adults in our country either have bad credit or no credit. So if you are reading this, it is more likely than not that you either have some credit issues, have had some or will have some at a later date. It also means that you probably know someone who is having credit difficulties right now.

Obviously, this is not ideal but there is a solution to it. Just like in any other game we play in life, one must know the rules in order to win at that game. This applies to sports, board games, jobs, relationships and money, among other things.

Unfortunately, we were not taught anything about credit in school and most of our parents didn’t know much about it so they couldn’t teach us either. Credit education is vital but is not being done.

This put all of us at a disadvantage and opened the door for us to make mistakes that could cost us a lot of money.

Even though our parents didn’t teach us about credit, we can’t blame them. Most of them were already using credit before credit scores were commonly used. There was no information available to them so it is now up to us to educate ourselves and our children so that they can have the opportunity to do better and make less mistakes than we have made.

For more information about credit, you can find my book, Crack The Credit Code, To Play The Game, You Need To Know The Rules which is available on Amazon. Or, go to my website, CrackMyCredit.com.

 

Credit Scoring Explained – Part 1 of 5

You may already know that the biggest part of your score is determined by your payment history. Lots of people know this but they don’t really know how much of their score is caused by it or what the different pieces of it are.

Even though your payment history is the biggest part of the calculation of your credit score, it is still only 35% of it. It would make more sense to most people if the way they pay their bills was worth a lot more than a third of their score.

I couldn’t tell you how many times I have had people call me for a loan and tell me that their scores aren’t that high but that they pay everything on time every month and have done so for years. There is always a tone in their voice that tells me they don’t think it’s fair. Maybe it isn’t.

But fair or not, it is still the system we are working with. We may not be able to change the scoring system, but knowing how it works can help us overcome its pitfalls. So without further discussion, I am going dive into how your payment history affects your credit score.

There are three main parts of your payment history. They are recency, frequency and severity.

Recency means how recent any late payments have been made. If a payment was late this month, it will have a far greater effect on your score than if it had been two years ago.

You can even divide late payments or on-time payments into three different time-periods to see how much effect they will have on your score. Anything within the last 6 months will have the biggest effect. The next tier is from 7 to 24 months and the last tier is anything more than 24 months ago.

Frequency has to do with how many times late payments have occurred on your credit report. If you have only one late payment on your entire report, it shouldn’t affect your score too much, unless it is your only account but I will get to that later.

Severity has to do with how late a payment (or payments) have gotten. Nothing is reported to the credit bureaus unless your payment is at least 30 days late. So if you missed the payment due date and were charged a late fee, it does not mean that it will show up on our credit report.

Late payments are reported in 30-day increments. A payment could be 30 days late, 60 days late, 90 days late, 120 days late or 150 days late. That is the highest it goes on a credit report.

The 90-day late will have a far greater effect on your credit score than a 30-day late payment.

Combine these three things and that is 35% of your credit score.

For more information about credit, you can find my book, Crack The Credit Code, To Play The Game, You Need To Know The Rules which is available on Amazon. Or, go to my website, CrackMyCredit.com.

Credit Scoring Explained – Part 2 of 5

By now, you have learned that your payment history is the biggest part of your credit and that it makes up 35% of your score. This next factor makes up 30% of your score so it is almost as important as payment history.

It is credit usage and it is the percentage of your available credit that you are using. This only applies to credit cards or what your credit report refers to as revolving credit, meaning that you can use it, pay it down and use it again. This isn’t something you can do on a car loan or a mortgage.

An ideal situation is that you use no more than 30% of the available credit on your cards. But just because you go to 31% does not mean your score will suddenly drop, it will only be slightly lower than if you were using 29% of your available credit.

If you want your score to be at its best, your usage would need to be under 10% but, believe it or not, it should be above zero. In other words, your score will be higher if you use some credit than if you don’t use any at all.

Other important thresholds on credit usage are 50%, 75% and 100%. When your usage goes over each one of these, your score will drop, especially if you go over 100% which means you are over your limit.

When you consider that 30% of your score is based on the percentage of credit you are using, it becomes important to have more credit than you actually need. The question becomes, how much credit do you need? And the answer is calculated by first figuring out how much you are going to use.

If you expect that you are going to use $5,000 on credit cards, you should have about $20,000 in available credit. This would keep your credit usage at 25% which puts you under the first threshold of 30% usage. To the credit bureaus, this means you “use credit responsibly”.

It may not be possible to have enough credit to keep your usage under 10% or even under 30%. If this is the case, do what you can do keep it under 50%.

For more information about credit, you can find my book, Crack The Credit Code, To Play The Game, You Need To Know The Rules which is available on Amazon. Or, go to my website, CrackMyCredit.com.