The recession may have done a number on your credit score, even if it spurred you to reform spendthrift ways and cut up your credit cards. For many, the drops have come at the same time that lenders have tightened their standards and demanded higher scores to get the best interest rates.
Even if you haven’t had major credit troubles, like a foreclosure, your score may have dropped if you missed a few deadlines or boosted your balances when cash was tight. A study by credit bureau Experian found that average credit card balances in the top tier of borrowers are 22 percent higher than they were a year ago.
And some people’s scores have suffered even though they thought they were doing everything right. Credit card companies have been lowering credit limits and closing accounts in an attempt to minimize their risk — 13 percent of people surveyed in January by Credit.com said their card company had lowered their credit limit over the past few months, and 11 percent said a card company closed their account.
Your credit score is the numerical summary of the information in your credit reports, which lenders use to predict the likelihood that you will repay your loans. The most common score that lenders use is the FICO score, which ranges from 300 to 850. The higher the score, the better. The median score tends to run between 710 and 720.
Your credit score can have a surprisingly large impact on your life affecting not only interest rates and terms made available to you, but your ability to get an apartment, cellphone service and affordable car insurance. And this magic number can make or break your ability to qualify for a good mortgage deal.
“It has become a very score-driven industry,” said John Ulzheimer, president of consumer education for Credit.com. You generally need a credit score of at least 620 to qualify for a loan that can be bought by Fannie Mae or Freddie Mac, which gives you a wide range of mortgage options. Borrowers with low credit scores have always found the Federal Housing Administration mortgage program more welcoming, but even the FHA is growing more demanding about scores. The agency has proposed that, starting this summer, the program allow only borrowers with scores above 580 to qualify for a loan with 3.5 percent down payment. Those with scores below 580 would be required to make down payments of at least 10 percent.
Brad Sherman, vice president of residential lending for Nationwide Mortgage Services in Rockville, said most people need a 740 or higher to get the best rates these days. For people with scores below that level, Fannie and Freddie generally base rates on 20-point brackets of credit scores — the lower your score, the higher your interest rate and the higher amount of equity, or cash down payment, the lender will require. “Having more equity in a house could counteract a poor score, but you still need to have at least a 620,” Sherman says.
Just under one-third of your score is based on the amounts you owe. A key element is the portion of your available credit that you’ve used, called your “credit utilization ratio.” Your available credit shrinks when your card company decreases your credit limit or closes an account. If the balances on your other cards remain the same, then your utilization ratio goes up and your score can go down.
There’s good news, however, for homeowners whose home-equity credit lines’ limits have been lowered because of declining property values. Such limit reductions do not affect credit scores.
Even a relatively minor score change can make a big difference in your interest rate. According to the FICO Web site, borrowers with scores of 760 to 850 paid average rates of 4.613 percent on 30-year $300,000 mortgages this week, while those with scores of 660 to 679 paid average rates of 5.226 percent — translating to a payment difference of about $40,300 over the life of the loan. (You can run your own numbers at http://www.myfico.com.)
No matter what happened to your score during the recession, taking the following steps a few months before you apply for a mortgage can improve your score and translate into big savings.
Check your credit reports from all three credit bureaus, Equifax, Experian and TransUnion. Your credit score is based on information from your credit reports, and errors can unfairly hurt your score.
Start paying down credit card balances. “It’s the fastest way to improve your score,” said FICO spokesman Craig Watts. The lower your balances, the better for your score. Keep in mind that it’s the balance that the credit card company reports to the credit bureau that counts — usually the total charges reported on your monthly statement — not whether you pay your bill in full. Ulzheimer recommends keeping your balances below 10 percent of available credit, starting three to six months before you apply for a mortgage.
Pay your bills on time. This is the most important factor in your credit score. Late payments remain on your credit report for up to seven years but have a smaller impact on your score as time passes. If you’re having cash-flow issues, make at least the minimum payment by the due date, which is more important to your credit score than whether you pay the bill in full. And be vigilant about payment changes — several card companies increased their minimum payments from 2 percent to 4 percent or 5 percent over the past several months, which caught many cardholders off guard.
Don’t close accounts before applying for a loan. Closing credit card accounts can never help your score, Watts said. In fact, your score is likely to drop if you close the account and maintain the same balance on your other cards, which increases your utilization ratio. Even though you may want to stick it to the card company after it raises your interest rate or imposes a new annual fee or inactivity fee, wait until after you get the mortgage to make your move. Then pay down the balances on your remaining cards so you can keep your overall utilization ratio low.
Avoid opening new cards in the months before taking out a mortgage. “Each time you apply for a new card, there’s a very slight impact on your credit score,” said Steven Katz, a spokesman for TransUnion. “Three or four applications over a period of months multiplies that impact and can have the effect of making you look credit-hungry in the eyes of lenders.”
Pay off old fines. A library fine, parking ticket or missed utility bill can ding your score by as much as 100 points if the account ends up going to collection. Check your credit report for signs of trouble, and pay off any old fines before they come back to haunt you.
By Kimberly Lankford
Special to The Washington Post
N.B. targets credit-score insurance screening
The New Brunswick government is looking at legislation that would stop insurance companies from basing premiums on customers’ credit scores, says the provincial consumer advocate for insurance.
If implemented, New Brunswick would become the first province to ban the practice, said Ronald Godin, who criticized the industry in his annual report, released Tuesday.
As it stands, the practice is currently being used by a limited number of companies and only for house insurance, said Godin, based on complaints to his office. But he expressed concerns that the practice could grow in popularity and expand to include other types of insurance, such as auto.
A bad credit rating can double a customer’s premiums, while some companies have even refused to renew policies, said Godin.
The problem is that credit ratings don’t paint an accurate picture of someone’s insurance risk, he said.
“Credit scoring captures people that are innocent in the sense that it’s as a result of illness, as a result of loss employment, as a result of a business venture that’s gone wrong.
“You’re a young couple, you’re just starting out, of course you’ve got loans and your ratio is quite high. Or seniors who have had no credit history for many years.”
A bad credit rating can follow people for up to six years, said Godin.
It means those who can least afford it are having the hardest time getting insurance, he said.
“The use of credit scoring by insurance companies as an underwriting tool for personal property is not a new practice, but it’s becoming more and more prevalent,” the report states.
Godin estimates about 20 per cent of insurance companies in the province currently use credit ratings when calculating premiums.
“We have serious concerns with this practice and we feel very strongly that it is not in the best interest of consumers seeking to purchase or renew their insurance,” he wrote.
“As a matter of social policy it should not be allowed in the property and casualty industry market.”