It’s not just banks and lenders that rely on credit scores to help make important credit decisions. Landlords, employers, insurance companies, and even cell phone and other utility companies all reportedly utilize credit scores to help determine their business and credit relationships with consumers. This means that your credit score is the most important component of your entire financial portfolio. Because of this, monitoring and managing your FICO score is vital, especially if you’re looking to buy or refinance a home any time in the near future.
The FICO scoring system was created in the 1960s by Fair Isaac Corporation and has been the standard for lenders since the 1980s. FICO credit scores typically range between a low score of 350 and a high score of 850. Under the FICO system, securing credit becomes less expensive for borrowers with higher scores (those who represent the least risk) and more expensive for borrowers with lower scores (those who represent the most risk). In fact, when it comes to a mortgage, a lower credit score could easily cost a consumer hundreds of thousands of dollars more in interest throughout the life of the loan, compared to the same loan with a higher score.
FICO Scores APR Monthly Payment
760-850 5.751% $1751
700-759 5.973% $1793
660-699 6.257% $1849
620-659 7.067% $2009
580-619 9.165% $2449
500-579 10.194% $2676
Source: MyFICO.com (30 year fixed-rate mortgage on $300,000)
The above chart from MyFICO.com clearly reveals the relationship between higher FICO scores and lower interest rates and monthly mortgage payments. According to Experian®, one of the three main credit bureaus in the US, FICO scores also accurately reflect “the likelihood of borrower becoming delinquent on a loan or credit obligation in the future.” In other words, the FICO scoring model looks to the past to “predict” the future risk a borrower represents to a bank or lender, and then prices the loan accordingly.
Not long ago, a FICO score of 680 was pretty good. In a tough credit market like today’s a 680 could be devastating to the bottom line of consumers looking to buy or refinance a home. In fact, thanks to Loan Level Price Adjustments (LLPA) from Fannie May and Freddie Mac, having less than a 720 in today’s credit environment will cost you big: up to a 2% increase in your interest rate!
LLPA’s and mandatory surcharges based strictly on credit scores. They are additional fees paid to Fannie Mae or Freddie Mac, not your mortgage professional. Analysts suggest that imposing these “penalties” is a blatant effort to recoup – and to help lessen further losses – on foreclosures. The surcharge could mean thousands of dollars for borrowers who do not monitor and maintain a good credit rating.
7 Steps to Credit Restoration
Step 1. GET RID OF YOUR COLLECTION ACCOUNTS.
Pay off all collection accounts willing to withdraw reporting from credit bureaus. Request a letter stating their agreement to delete the account upon receipt of payment.
Step 2. GET RID OF YOUR PAST DUE ACCOUNTS.
Past dues destroy a credit score. Pay the creditor the past due amount reported immediately.
Step 3. GET RID OF YOUR CHARGE-OFFS AND LIENS.
Charge-offs and liens within the past 24 months severely damage your credit score. Pay the past due balance first, and then pay collection agencies that agree to remove all references to credit bureaus second.
Step 4. GET RID OF YOUR LATE PAMENTS.
Request a good faith adjustment that removes the late payments. Persistence and politeness pay off in this scenario. If you are frustrated, rude and unclear with your request, you are making it very difficult for them to help you.
Step 5. CHECK YOUR CREDIT LIMITS AND EVENLY DISTRIBUTE THE BALANCES.
Make sure creditors repot your credit limits accurately. Maximize your score without sending money by evenly distributing your credit card balances among all of your credit cards, rather than carry a large balance on one credit card.
Step 6. DO NOT CLOSE YOUR CREDIT CARDS.
The magic number of credit card accounts to have in order to ensure your score is between 3 and 5. If you have more than six department store cards, close the newest accounts. Otherwise, do not close any at all.
Step 7. KEEP YOUR OLD CREDIT CARDS ACTIVE.
Use cards once every 6 months. Closing those cards will decrease the average length of time you’ve had credit. The one thing all credit scores over 800 have in common is a credit card that is twenty years old or older.