Protecting Your Credit and Credit Score in Today's Economy
The economic fallout from the national credit crisis and recession has continued to hit hard at personal finances. Many consumers are facing tightened credit availability as they seek credit for a mortgage or car loan, for instance. Credit card companies have been lowering credit limits and closing accounts at record levels, even for customers with good credit, in an effort to recover from past losses and reduce future risk exposure. Meanwhile, layoffs have continued and our collective sense of job security is lower. Even though some recent economic indicators have been positive, economic recovery is still a ways off. Smart consumers know that protecting their credit and credit score in this uncertain climate is very important. In this report, we'll look at some expert recommendations for achieving that goal.
First, some basic facts about credit and credit scoring
Credit, at its simplest, is your ability to borrow money. Creditworthiness is a creditor's judgment of your ability to pay back the money you've borrowed or wish to borrow. Such judgments are based on your history of using credit, which is reported in credit reports, particularly those compiled by the Big Three credit reporting agencies—Equifax, Experian and TransUnion.
Credit scoring is a system of statistically analyzing credit reports that provides a simple three-digit credit score comparing an individual's past and current credit performance to that of similar consumers. Your credit score provides lenders, or other potential creditors such as insurance companies or landlords, a quick, fairly objective way to assess your creditworthiness—or likely ability to pay back a loan or mortgage or pay the rent.
In the most common scoring model, the FICO score, the score ranges from 350 – 850. The best scores, indicating high creditworthiness range from the mid 700s up. Scores below the mid 600s are considered poor. In today's tight credit market, experts point out that typically you may need a score of 750 or higher today, to get a loan or loan terms that required only 700 before the credit crunch.
The credit score is often called a "FICO score," after the company which developed the scoring model(s) most widely used. However, the actual picture is more complex because there are many customized, modified and adapted models of the FICO score and competing scores such as the VantageScore that lenders and businesses may use. (See the first two resources in "For More Information" for more about credit scores and how they work.)
Now, what you can do to protect your credit and enhance your credit score
Review your credit report regularly and correct any errors. I put this tip first to remind you that your credit report is the basis of your credit score (even in models that consider additional items). Your credit score goes up or down based on the information in your credit report. All the following tips outline actions that will be positively reflected in your credit report. Important errors to look for include:
- incorrect indications of late payments, partial payments, charged off accounts, or collections
- lower credit limits on credit cards or revolving accounts than the actual limits
- accounts or loans listed as unpaid that have been paid.
- negative items older than 7 years (10 years for bankruptcy)
Go ONLY to www.annualcreditreport.com for the federally mandated annual free credit report from each of the three major credit reporting agencies or phone 1-877-322-8228. (Typically, you'll have to pay for an accurate credit score; myfico.com is probably the best service overall. Your credit union may provide it if you are applying for a loan or through another service.)
Pay your bills on time—all bills, every time. This is probably the most important thing you can do to protect your credit and credit score. Paying on time also applies not just to your mortgage, auto loans and credit card accounts but to all other bills, such as utility bills. How late, how often you've been late, and how many accounts you've been late on all affect your credit score negatively. Any collections, liens and judgments also count negatively.
Pay down any balances on credit cards. Credit scoring models also look at how much you owe in relationship to the amount of your total credit limits. Until recently, the rule of thumb had been to keep your balances under 30% of your credit limit. But with more stringent credit standards now in operation, experts are consequently recommending that to achieve the best rating in this aspect of the scoring, balances should be no more than 10% to 20% of credit limits.
Avoid large balances or maxing out credit limits. This tip is a twin to the previous tip. If you have a large balance on several cards, you may want to consider a consolidation loan with the credit union, particularly if interest rates have risen on any of the accounts. Such a loan with your credit union may have a lower interest rate and a fixed, manageable monthly payment. But avoid running up new balances on those cards after you've paid them down.
Keep older accounts open—don't close them. In general, the longer your credit history the better, particularly if you've handled that credit responsibly. If a card issuer has raised the interest rate on a card to a level you dislike, if you have a low balance or no balance or a card with a high credit limit, keeping the account open helps maintain your credit limit. If you are carrying a balance, rather than close the account (particularly if it is one of your older accounts), consider moving the balance to another card (or cards) or paying it off with a personal loan from the credit union.
Don't attempt to open many new accounts in an attempt to increase available credit. Multiple applications for new credit (unless they are applications for one purpose such as a mortgage or credit card within 14 to 30 days) count negatively against your credit score. Requesting your own credit report, however, does not affect your score.
What if you've already had difficulty? How can you recover? Time is the most important factor in recovering from accurate, negative information in your credit report. Perhaps, you've made several late payments. Then, begin to pay your bills on time, every time and typically in six months or so, your score will begin to rise again. The older the negative activity, the less importance scoring models give it. If you've had greater problems such as a foreclosure or a bankruptcy, it takes time to rebuild your credit. Experts recommend that you start rebuilding good credit practices as soon as possible. The credit counseling services available through your credit union can help you establish a plan.
A final tip: avoid credit repair services. Unfortunately, the credit crisis has led to an explosion of credit repair scams and so-called "services" that at best over-promise what they can deliver. Promises such as "better credit in two days" are just pie-in-the-sky. Nothing but time can take correct negative information off your credit report. And even the best companies can't do anything to correct errors or take action to use credit more wisely that you can't do yourself for free. But most services charge a bundle. For example, recently a consumer in the western U.S. filed a complaint—she had paid an upfront fee of over $1000 and then $99 a month for what she heard as a promise to remove negative information from her credit report only to discover in almost a year her score had not changed and hidden in the fine type of her contract was the word "inaccurate" to describe the negative activity they would work to remove from her credit report. If you need help with credit counseling or debt management, ask your credit union for help or referral to a reputable service.
For more information
On credit scoring
- For an overview of credit scoring from the Federal Trade Commission, see: Need Credit or Insurance? Your Credit Score Helps Determine What You'll Pay
- From the Washington Post, Credit Score Shell Game (June 20, 2009) by Nancy Trejos provides information on the many scoring models and more recent developments in their use.
On improving your credit score
- From the Federal Reserve: 5 Tips for Improving Your Credit Score
- From the Federal Trade Commission: Building a Better Credit Report
From Consumer Reports