More Foolish Advice!

A few weeks ago I was doing a public speaking event and one of the questions I received was “what is the best way for someone with no credit to build a credit score?” Before I answered the question the person got even more specific and told me that a bank had told him the best thing he could do was to deposit $1,000 (with this institution) then to take out a $1,000 installment loan against that deposit.

I am sure the bank had lots of “great” reasons as to why this was helpful advice, but telling someone this is the best and fastest way to build a credit score is where I take issue. Let’s address the issue of time first.

In order to generate a FICO score two things have to happen;

1. You have to have an account that has been open for at least 6 months (collection accounts do not count)

2. You have to have an account that has been updated to the credit bureaus at least once in the last 6 months. One account can work to qualify for both of these rules.

In looking at the criteria listed above you will not see that it mentions the “type” of account as a factor, since it doesn’t then we know the “type” of account is not a factor in how long it will take to generate a score! So in answering the time question of the equation the answer is 6 months if you currently have no credit now. Regardless of the “type” of account!

Let’s look at the other issue now; the goal is not to just have a score, but to have the best score we can.

If you understand how the FICO score works you know that revolving accounts (credit cards) hold a much higher value than installment loans. Knowing that is why I disagree completely with the advice from this bank. In this scenario it will be a lot better to get a credit card and use it properly, than it would be to get an installment loan. For someone with no credit at all the biggest challenge will be what type of card to apply for to have the best chance to get approved. For this situation we want to get a secured credit card. In case you are not familiar with this term, very simply it is a credit card where the limit is secured by a deposit. Most banks have a minimum amount of $250, so you give the bank $250 that they hold as a deposit, you then get a credit card with a limit of $250. This is what makes the account secured. Since it is secured it is a lot less risky for the bank which makes it a great option for people with no credit or damaged credit.

Comparing these two ideas, both will take 6 months to generate a score, the revolving approach will yield you a higher score when you generate a score than the installment option (if you use it correctly) and the last factor, with the banks installment idea it will tie up $1,000 of your money vs. only $250 with my approach!

Be careful with the advice you listen to when it comes to your credit. Clearly the bank had an ulterior motive with this type of advice. It sounds to me like it is a plan to generate higher deposits instead of the best and fastest way to generate a FICO score for this person!

How long will it stay?

One of the most common questions I get from people is regarding how long certain items will remain on a credit report. Many people have heard all kinds of crazy answers, especially when it comes to negative information. People are usually shocked to find out how long something can stay on their report or they have been told lies by collection companies trying to scare them into making a payment. Here is the real truth about accounts and credit reporting limitations.

Accounts Paid on Time –Accounts that have never been late can stay on your credit report indefinitely or can be removed ten years from the last time the account had activity. If the account is closed, this would be based upon the date it was closed. If the account still has activity, it will stay until there has been no activity for 7 years.

Bankruptcies – Chapter 7, 11 and non-discharged or dismissed chapter 13 bankruptcies are removed in ten years from the filing date. Chapter 13s are removed seven years from date discharged, but not to exceed 10 years.

Charge-offs – Charged off accounts are removed seven years from the date it was charged off.

Collections – There are two types of collections: the original account, which was turned over to collections and an account reported by a 3^rd party collection agency. Original accounts remain for seven years from the time they went 180 days delinquent prior to the default. Accounts reported by a collection agency remain for seven years from the same date. This means that the collection can remain on your report no longer than the original account that went into default. No where in that statement did I mention “from the date it was PAID” this is because paying a collection does not change how long it can be reported to your credit report.

Inquiries – Inquiries are placed on your credit report to indicate who has looked at your credit report. Inquiries that you initiate from an application (such as credit card, auto or mortgage loan) will remain on your credit report for 2 years. These type of inquires are commonly known as “hard inquires” and they can negatively affect your score. When you request your own credit report, that inquiry stays for 6 months and nobody other than you sees it. Inquiries that you didn’t initiate, such as pre-approved credit offers or companies monitoring your credit report, remain for 6 months and are not seen by other companies and do not impact your score.

Judgments – Judgments stay on the credit report seven years from the filing date.

Repossessions - Repossessions are removed seven years from the date your auto loan went into default.

Tax liens – Tax liens include federal, city, state and county liens. They remain seven years from the date they’re released. If they aren’t paid they can remain indefinitely.

Keep in mind all these times are the maximum things can stay, that doesn’t mean they can’t come off sooner. Also unfortunately not all companies always follow the rules, just one more reason to check your reports regularly for inaccurate reporting.

Finally the TRUTH about Mortgage Inquiries

Understanding how inquiries impact your FICO score is easily one of the most complicated aspects of the scoring system. This is easily on the “Top 5” list of the most misrepresented facts about FICO scores. In efforts to clear this up here are some truths about credit inquiries and how they relate to your FICO score. What you will read is 100% accurate.

1. Inquiries are all specifically coded by the credit bureaus to reflect the industry from which they came. This means whatever “type” of credit you apply for will likely be clearly indicated. This is important because the “Type” of inquiry plays a key role in how it is evaluated.

2. Mortgage, auto and student loan inquiries are treated differently from all other inquiry types. If you don’t already know, these are the type of loans that you can shop for the best interest rates and terms. Shopping for these loans most likely will result in your credit report being loaded up with multiple inquiries in a short amount of time.

3. FICO doesn’t want to penalize smart consumers for rate shopping. So, rather than assume each inquiry indicates a discreet and unique credit application, they have built logic in their credit scoring model that identifies when you’re shopping for one loan rather than many loans.

Here’s how these 3 rules work in a mortgage application example…

Mortgage related inquiries, which are very easy to identify because of #1 above, are ignored for the first 30 days they’re on your credit reports. If you were to apply for a mortgage on August 15^th it will take until September 15^th to become “visible” to the FICO score. This means you can apply with 50 different mortgage loan lenders during that 30 day window and all 50 of those inquires will be ignored for FICO scoring purposes. In other words these inquires will have absolutely NO impact to your FICO score.

When the mortgage inquiries age past 30 days they become fair game and will be seen by the FICO scoring system. The rule doesn’t end there however. Any of those inquiries that occur within the same 45-day period will be treated as 1 inquiry for scoring purposes. So in my crazy example of applying for a mortgage with 50 different lending companies all those will only be counted as 1 inquiry because they all would have happened within 45 days of each other.

Many years ago the 45-day period was only 14 days. For this reason, you still hear some people claim that you only have 14 days to shop for a mortgage, which was true about a decade ago but isn’t true any longer.

These rules apply not only to mortgages but also to auto loans and student loans. It does not however apply to credit cards, which means if you apply for 3 credit cards then the 3 inquiries will immediately be seen by the FICO score AND they’ll all be considered unique loan/credit applications.

It will surprise you!

One of the most common questions that I receive has to do with what would be the best thing to payoff to improve someone’s FICO score. Judging by the frequency of the question and the overall surprise of the answer I thought it would be a good “FICO Score pop quiz” question, so here you go!

Which of the following would improve your FICO score the most?

A. Paying off a $2,000 Collection

B. Paying off a $30,000 Auto Loan

C. Paying off a $300,000 Mortgage loan

D. Paying off a $7,000 Credit Card

Before you answer there are a few ground rules to this quiz. First, the starting score is a 620. This is important for a few reasons but mainly because this is a score that needs improvement. Second, the payoffs of the accounts are a payment in full, not a short sale or settlement and everything else on the credit report remains the same. OK, good luck!

Using a scoring tool built by FICO here are the results…

Paying off the collection account in this case actually decreased the FICO score!

Your FICO score is more concerned with the incident when it comes to collections not the balance. People get this idea that if they pay off their collection accounts that it is going to magically improve their FICO score. Reality is, doing this will have a slightly positive to neutral effect on your score. However things can go wrong, most commonly if dates get updated on the account it can appear as if it’s a new collection which will cause a negative impact to the score! Talk about great motivation to pay off a collection!

Paying off the auto loan had a 5 point improvement

Balances or lack of balances on installment debts are not that important to the score and this simulation provides more proof. A lot of banks that want to “help” their customers improve their FICO score sell them on this idea of having the customer give the bank $1,000 to put into a CD and then using that as collateral on a $1,000 installment loan. They usually tell the customer that by doing this they will get a new installment loan on their report which will be great for their credit score. Keep in mind this is not an interest free loan by any means. I know their motives are only to “help” the consumer improve their credit rating but this approach is not the best answer!

Paying off the mortgage had a 5 point improvement

Guess what, a mortgage loan is just another installment loan! This helps to squash the Myth that the larger the balance, the more it hurts your score idea. Pay off your mortgage to save money on the interest if you want too but don’t get caught up in the idea that this is a credit building tool.

Paying off the credit card improved the score by 35 points!

Credit card debt is considered more risky than installment debt because usually installment debts are secured by some asset. This is the reason that revolving accounts (credit cards) play a much bigger role in the score. In this simulation we paid off one revolving account all together as well as lowered our overall “utilization” to less than 10 percent, both of which are great for our FICO score.

These results are simulated, but prove that when it comes to paying off debt to improve your FICO score use it on credit cards.

You Have Got to be Kidding Me…or Maybe Not?

Sen. Dick Blumenthal wants explanations from the three credit rating bureaus about a New York Times report about a VIP list they allegedly keep that favors the rich and famous over everyone else. The article says the Connecticut Democrat wrote a letter Monday to Equifax, Experian and TransUnion about the reported separate system in which errors and disputes are resolved faster and with more attention than with other consumers, who must rely on an automated system and outsourced customer support to clear up mistakes.

"I am deeply troubled by the implication that your companies are neglecting the majority of consumers and providing preferential treatment for wealthy, famous or well-connected persons, and I ask you to confirm or deny these reports and provide more information on your dispute resolution process," he wrote in the letter.

"An error-free credit report is vital to a consumer's financial health, and consumers must be able to quickly resolve disputes and mistakes with the cooperation of the credit reporting bureau," he wrote. "Every consumer deserves this cooperation, not just the rich and powerful."
But the credit bureaus deny keeping VIP lists, all according to the article On May 17, 2011 FoxNews.com.

The good news is now we all know what may be the easiest way to ensure ourselves a good credit score...just become rich, famous and well connected! Just in case you think that might be an unrealistic plan for you, here are 5 solid tips that everyone should know and follow.

#1 Pay your bills on time. Of course you should pay your bills on time, it sounds simple but it doesn’t just stop there. If you get in a situation where it is impossible to pay the minimum on all your bills, try to look ahead and see if you can get things caught up before they go 30 days past due. This is important because if you are reported as 30 days past due, this will be a negative on your credit report for 7 years. Know that just paying your bills on time is not a guarantee for a good credit score! Since this area makes up only 35% of your FICO score, you need a more comprehensive credit plan in place, but this is a good start.

#2 Keep your credit card balances low. This is the most misunderstood component of the FICO score. Most people have no idea what this really means and more importantly what is optimal. Too make this as simple as possible, make your overall goal to only have a balance of 7% or less of the total limit, for example if your credit card limit is $100 try to have the balance be $7.

#3 Do not close your credit card accounts. This advice is easy and applies to just about everyone, so if in doubt, leave the card open!

#4 Only apply for things you need! Be strategic about the things you apply for. Only allow someone to pull your credit if you need the credit or you are doing things to build your credit profile. In case you are wondering, getting 10% off at your favorite department store by applying for their credit card is not a “need”. Stay away from those “spur of the moment” decisions when it comes to your FICO score.

#5 Check your credit regularly for errors. Whether the bureaus want to admit it or not, a large number of credit reports have errors. Check yours to make sure it is accurate. I recommend going to www.annualcreditreport.com. You are able to check with all three bureaus once every 12 months and it is free. They might try to sell you a “credit score” for $7.95 but don’t waste your money on it. Get the free report and look it over carefully.

These are five easy tips that can help you take control of your credit life. And they are not unrealistic or far-fetched. They are simple and anyone, not just the rich and famous, can do them. Good luck, and as always remember credit education is extremely important, make sure that the advice you follow is from an expert and complete.

They REALLY don't care about you!

The Government Accountability Office states that as much as 80 to 90% of credit reports have serious errors on them. In other words, only 1 or 2 people out of every 10 actually have a credit report that is 100% accurate! Not exactly the best success rate. Granted not every error on a credit report will directly effect that person’s credit score, but a huge majority of them will. The credit score world we live in is not like our judicial system, you know “innocent until proven guilty”. This system is the exact opposite, you are guilty unless you can prove yourself innocent, that is assuming you even knew how to do this.

If you were wrong 80 to 90% of the time and most likely every time it happened you were responsible for costing someone thousands of dollars or worse crushing their dreams, how would you respond? Most people would do everything they could to fix the problem and help their victims recover as fast as possible. Sadly when it comes to the accuracy of your credit report there is a different philosophy being employed.

The “Big Three” (Transunion, Experian, and Equifax) have a much different way of dealing with this major problem. Most of us know that if there is something wrong or inaccurate on our credit report we have the right to dispute that information. Disputing it is how it will get fixed, but did you know that there are several ways or methods to go about disputing something?

If you look at the websites of the “Big Three” they will make it really easy to dispute anything that is inaccurate on your credit online with just a few clicks of the button through their online dispute process. Have you ever wondered why they would push this option so hard, and make it so easy for you to complete? It has to be so their product (your credit report) is as accurate as possible, in the shortest amount of time possible, and this is the best way to ensure future accuracy, correct? How would you feel if you learned that by following these instructions to fix their error, in reality all you are doing is waving several of your rights and changing the things they are required to do by law?

By disputing online you agree to make the “Big Three’s” job easier by having preselected generic ways that you can dispute something. There is no paper trail to even prove you actually do dispute something, and you allow them more time to “investigate” your dispute. All of this along with a few other minor details like waving your right to be notified if a previously deleted negative item is re-inserted back on your credit report. By using the online method, you allow them to not have to send you any results of the investigation and lastly give them more loopholes as to what information the original creditor has to provide. All these things will greatly hinder the chance of you getting your credit report corrected.

Don’t just assume the bureaus are right or that they are doing anything in reality to help you improve or maintain a good credit score. That is not the business they are in. Having you dispute online is just one more way they prove how little they really care about you having an accurate credit report. It is pretty clear that the real motive of the credit bureaus is only to make money, to sell you worthless add on products, and confuse you. Even when they recognize their product has flaws, their first instinct is to create a way of dealing with that problem by making their job easier, not one that will ensure the best accuracy possible. Credit bureaus make money storing and reporting data, unfortunately for us nowhere in that statement is the word ACCURATE data.

Why are you paying that Collection?

When it comes to collections, and more importantly paying past collections, there are two common myths that consumers have. The first is that paying a collection will remove it from your credit report. It would be great if that were the case but unfortunately that is not how the FICO system works. Paying a collection will just have the account updated to a zero balance, but will not do anything for you as far as removing the collection from your report. Collections can stay on your report for 7 years from the date of first delinquency.

The second most common myth I hear about collections is the idea that paying a collection will somehow drastically improve your FICO score. If you understand the purpose of the FICO scoring system, which is to predict the statistical chance of consumer being 90 days late or more in the next two years, you will understand how this belief is flawed. If the purpose of the FICO score were to predict the statistical chance of a consumer paying a collection then yes, paying that collection would be fantastic advice for credit score improvement. In most cases paying a collection will have a neutral to slightly positive effect on your FICO score.

I am not saying don’t pay your collections if you have them, I just want you to know what to expect by doing so. There are several reasons for paying your collections, just understand that if you are hoping for a large score improvement or that the item will be removed from your credit report you are greatly mistaken.
The FICO score cares about the incident, meaning the fact that you had the collection in the first place, not the balance. After paying a collection the incident needs to be addressed. If you are able to get the collection removed from the credit report one way or another then you will see the improved credit score you were hoping for.

Obviously the best advice is to not let accounts get to the collection stage, but there may be circumstances that you cannot control which lead to collections. If you get a collection letter and have the ability to pay it, always ask the Collection Company if they will remove the incident from your report when you make the payment. This doesn’t always work, but it is worth a shot, if you are successful you will save your FICO score, which in this day in age is extremely important.