What's the Score? Maintaining Your Credit Score During Tough Times
Maintaining Your Credit Score During the Continuing Credit Crunch
It’s always a good idea to be vigilant about your credit score, but even if borrowing loosens up a bit in 2009, you still need to do everything necessary to keep your credit score high. Why? Because your fiscal health depends on it.
Fair Isaac, the company that created the ubiquitous FICO score used almost universally for lending since the early 1990s, has been working on a new version of its landmark credit scoring method that might have serious consequences for you if you’re planning on borrowing for a home or establishing any other new credit in 2009.
The new version of FICO is going to be particularly focused on your balances, not only on your on-time payment records.
Your Number One Priority: Get balances down.
Reports say that the new FICO revision will actually allow a bit more leeway on late payments – something that might affect more than a few consumers in this recent downturn. Obviously, this won’t mean that someone can chronically pay late, but once or twice won’t make the same impact as in earlier FICO versions.
Yet credit utilization – essentially the amount of credit you’re actually using relative to your credit limit – is a much bigger deal simply because high balances are so prevalent right now. From the lender’s perspective, high balances mixed with a tough economy means a higher risk of default among customers.
So what’s a good target utilization rate for all your revolving credit accounts? No more than 50 percent of your credit limit, and if you can get it significantly lower than that over time, that’s a good plan. So, the lower your credit utilization, the better your score. Think of it like the winner of a limbo contest: lowest is best.
What does that mean for ordinary Americans who don’t meet that under-50 percent goal? It means you shouldn’t be applying for new credit or refinancing for awhile. But because most lending institutions may continue their strict lending requirements, you might as well defer borrowing goals in favor of reforming your credit behavior.
So instead of bemoaning your tougher chances of getting a loan for a home or a car, why not use the current environment to launch a credit makeover that will position you for a better shot six months to a year from now?
Some ideas:
You’ll need at least a 740 score for the best rates: You’ll often hear that credit scores of 700 and up will get you best customer status with lenders. You should aim higher. For the lowest rates and best terms, you need to get your credit score above 740 (the top credit score, by the way, is 850), so keep that target in mind.
Budget: If you’ve never reviewed your spending and picked out areas where you can cut, you’re missing out on a huge opportunity to save. Start tracking your spending either on paper or with financial planning software and start pinpointing what spending you can shift over to paying off debt.
Worth Repeating -- get those balances down: Get all your non-deductible debt under 50 percent of your credit line in each account. Go after your balances with the highest interest rates first, and once you hit 50 percent, then direct more payments to the next card on the list. When you have succeeded on getting these cards below the 50% target, then move to pay down the remaining balances to zero.
Be careful with transfer offers: Transferring your credit card balance can be tempting but WATCH OUT! By opening a new credit line and transferring balances over, you’ll end up with a new consolidated balance that will likely be more than the 50% utilization limit. Coupled with a card without an established payment history, this will certainly ding your credit score. A better option might be to call your present card companies to negotiate a lower interest rate on your outstanding balances. You’re already an established customer and they certainly don’t want to risk losing the business. But have your leverage ready: Be able to quote the offers from their competitors that you received.
Get some advice: It might not be a bad time to sit down with a financial coach – such as a Certified Financial Planner™ professional -- to talk about the way you're going to manage your debt going forward. With a little coaching, you may find some creative options to cut out some small luxuries and direct the savings into paying down debt. Just think: Bagging lunch once a week can save maybe $10 or over $500 a year.
Keep an eye on your credit reports: Remember that you have the right to get all three of your credit reports from the national credit data reporting firms -- from Experian, TransUnion and Equifax -- once a year for free. You can do so by ordering them at www.annualcreditreport.com. Don't order all three of them at the same time, though. By staggering receipt of each of your credit reports, you'll get a continuous picture of how your credit picture looks because the three bureaus feed each other the latest information. You’ll also be able to clean up errors as you find them -- errors can drag down a credit score – and you’ll also keep an eye out for identity theft. Keep in mind that all “free” credit report sites are not free – if they ask you for a credit card number, they’re doing that because they want to charge you. Just go to the site above and you’ll be fine.
Get on time and pay more than the minimum: Yes, we indicated above that you might get a bit of a break on late payments with the new FICO system, but that’s a break you should consider only in a dire emergency. Electronic bill payment will allow you to save on postage while guaranteeing on-time payment. The budgeting advice mentioned above will allow you to put a few more bucks toward getting that loan or credit card bill paid off sooner rather than later.
Once you’re paid off, don’t close the account: In the world of credit scoring, closing accounts (even those that have not had balances for years) is a lousy idea. Lenders want to see a long record of credit management, and longtime accounts that you haven't touched in years may actually help your score because it shows you have some restraint. To avoid having the card closed on you by the creditor, use it once a year for a small purchase and pay it off in full the next month.
April 2009 — This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and has been modified and edited by Steve Stanganelli, CFP ® , a local member of FPA.
About Your Advisor
Steve Stanganelli, CRPC ®, CFP ®, a CERTIFIED FINANCIAL PLANNER ™ Professional and a CHARTERED RETIREMENT PLANNING COUNSELOR, is a five-star rated advisor who specializes in working with business owners, busy executives, medical professionals and their families to help them live richer lives through smarter money moves during life and business transitions.
Steve’s practice includes the areas of credit management, retirement planning, low-cost index investment strategies, divorce assistance, college aid planning and funding and asset protection for business owners and professionals.
Steve’s practice includes the areas of credit management, retirement planning, low-cost index investment strategies, divorce assistance, college aid planning and funding and asset protection for business owners and professionals.
Steve frequently writes and presents on these topics which can be found also at his blog at www.moneylinkpro.wordpress.com .