September 5th, 2017 7:07 AM by Jackie A. Graves, President
This probably comes as little surprise to most folks, but America
pretty much runs on credit. According to newly released data from the Federal
Reserve, aggregate credit card debt in the U.S. now totals $1.027 trillion, an all-time record. Aggregate credit card
debt also joins student loan debt and auto loans over the $1 trillion mark.
Given that the U.S. economy is 70% consumption-driven, this isn't all that
credit card usage is what's helping to build our credit profiles, which lenders
use to determine if we're worth lending to or if we should be shown the door.
Perhaps the best-known credit-scoring system comes from Fair
Isaac Corp., which you probably are familiar with as FICO. Your
FICO credit score ranges from a low of 300 to a high of 850. The higher you
credit score is, the more favorable your interest rates and options will be
when looking to get a mortgage or open a credit account. A higher credit score
can also help lower your home and auto insurance rates,
minimize or eliminate utility deposits, and help you land your dream job,
apartment, or home.
people are probably under the impression that there's a pretty definitive line
in the sand that can be drawn where you either have good credit or you don't.
But there's much more to it than that. If you're looking to buy a home,
mortgage lenders can charge a markedly different annual percentage rate (APR)
based on your credit score. In some instances, even a 10- or 20-point swing
could mean a lot of extra money out of your pocket over the life of a loan.
way of Informa Research Services, myFico.com recently published the average
APRs for a 30-year fixed home loan -- the most popular term for a mortgage --
based on a person's FICO score. Here's the breakdown, as of Aug. 23, 2017, for
a $300,000 mortgage:
FICO Score of 760-850: 3.512% APR
700-759: 3.734% APR
680-699: 3.911% APR
660-679: 4.125% APR
640-659: 4.555% APR
620-639: 5.101% APR
the first thing you'll notice is that there's no aggregate data for consumers
with a credit score of 619 or lower. Traditional lenders tend to avoid this
subprime group as a high delinquency risk. That doesn't entirely preclude those
with poorer credit scores from owning a home, though. Federal Housing
Administration (FHA) loans may offer assistance to those with credit scores as
low as 500, depending on how much you're able to put down on a home.
Nevertheless, scores of 619 and lower make it very difficult to get a
traditional home loan.
also note that a very prominent increase in APRs begins once you move well
beyond the "good" or prime category (700 and above) into the
"near-prime," or what we might call "average" scores.
Lenders have to account for an increased risk of default for those below prime,
and they do so by passing along higher interest rates and/or fees during the
homebuying process. APRs take into account interest rate costs, as well as
homebuying costs, over the life of the loan.
big of a difference are we talking with those APRs? As an example, a $300,000
mortgage for someone with an 800 FICO score would run $1,349 a month. The price
jumps to $1,387 a month for a 700 FICO score, $1,454 for a 675 score, $1,530
for a 650 score, and $1,629 if you have a 625 score. Again, these are average
figures from Informa Research Services, and your individual market and
relationship with your financial institution could have some bearing on these
APRs. Nonetheless, that's a big difference.
even bigger when we begin talking about life-of-loan costs. A consumer with a
FICO score of 800, utilizing a 3.512% APR, would pay $485,692 for a 30-year
loan, including interest. By comparison, an individual with a 675 FICO score
would fork over $523,422, and a 625 FICO score would pay $586,452. That's more
than $100,000 extra over 30 years for a credit score difference of as little as
121 points (639 to 760).
with poor credit scores are considered to be a bigger risk for lenders, and
therefore they have fewer lending options to begin with. On the other hand,
folks with excellent credit scores (760-850) have banks fighting for their
business, and thus the ball remains in their court.
no magic wand to wave that'll improve your credit score overnight. Instead,
sticking to the credit basics is going to be your best bet to improve your
credit score to secure the lowest APR possible when buying a home.
FICO is secretive about its exact credit formula, there are five factors that help FICO come up with
your score -- some clearly with more importance than others. Following are
those five factors, listed with their relative weighting in parenthesis:
Payment history (35%)
Credit utilization (30%)
Length of credit history (15%)
New accounts (10%)
Credit mix (10%)
you'll note, your payment history and credit utilization make up almost
two-thirds of your credit score, so this is where you'll want to focus most of
your attention if you want to boost your score as quickly as possible.
payment history takes into account the timeliness of your payments. If you have
a long history of paying your bills on time, your lenders are probably going to
be more willing to lend to you at an attractive rate. If, however, you do have
a recent late payment on your credit report, but you've had a long history of
on-time payments, consider asking your lender to forgive your tardiness. If
you're a good credit customer, chances are the lender will, because it costs
far more for lenders to get new customers than to keep customers with good and
excellent credit happy.
terms of credit utilization, FICO suggests keeping your aggregate usage below
30%. In other words, if you were to add your credit limits for all of your
credit accounts together, FICO would like to see you use less than 30% of that
amount. It's possible you may also be penalized for too heavily utilizing a
single card. The general rule here is to use credit wisely and avoid leaning
too heavily on your credit cards.
other three factors -- length of credit history, new accounts, and credit mix
-- make up the final third of your score. In this instance, your best bet to
improve your score is to keep long-standing good accounts open for a long
period of time. A big mistake consumers make is closing accounts in good
standing that aren't being used much. These accounts offer valuable data points
for lenders, and they can lift the average amount of time your credit accounts
have been open.
avoid opening new accounts that don't make financial sense (i.e., don't open a
department-store card to save 10% on a $15 purchase), and do try to demonstrate
that you can handle revolving loans and installment loans. Mortgages and auto
loans are examples of installment loans, while a department-store credit card
is an example of a revolving account.
keep in mind that bettering your credit score takes time. The more positive
data points you can provide, the better road map you create for lenders. This
won't happen overnight. But there's never a better time to improve your credit
score than now. What are you waiting for?
By Sean Williams - To view the original article click here