While the formulas are a secret, the elements of the FICO score are made public. The largest portion of your credit score is payment history, accounting for 35% of your credit score. The fewer times you’ve ever been late and the longer it has been since those late payments, the better.

So the number one thing you can do to improve your credit score is to pay your bills on time, month after month. If you’re not currently caught up, get caught up.

Another major factor that goes into your credit score is how much you owe. This accounts for another 30% of your score. Not only does this consider how much you owe, but the amount of your credit lines you are using. The smaller the balances, the better. If the amount you owe is at or near 80% of your credit limit, you are considered maxed out. After you’ve gotten caught up on your bills, the next thing to work on is getting the balances lowered. Bonus: this will help you save money as you’ll be paying less interest!

A third major factor is the length of your credit history, which figures for 15% of your credit score. This accounts for how long you’ve had the accounts, and how long it has been since there has been activity on your account. The longer you’ve had your accounts, the better, as you’ve proven your creditworthiness over time. If you have older credit cards that you no longer use, it is often best to keep them open, using them for small purchases a couple of times a year, and then immediately paying them off. Of course, if they have any time of annual fee, it is best to close them.

Of lesser importance are the types of credit you have and the number of newer accounts, each making up 10% of your score. For credit purposes, it is good to have some type of revolving account (credit card) and some type of installment loan (mortgage, car loan) currently or in your recent history. You also want to avoid opening multiple new accounts over a short amount of time.

The more you understand how your credit score is figured, the more you are prepared to improve that score.

It Depends on Your Unsecured Debt Levels

If you are using more than 25-30% of your total available credit on revolving accounts, then either closing an account or experiencing a reduction in your credit limits will reduce your score. There are two reasons for this.

First of all, closing an account will never help your scores and it could actually cause your scores to drop. This was confirmed by Craig Watts, spokesperson for Fair Isaac Corp. Secondly, any lost credit will increase your credit utilization rate which dominates the “total balance” portion of the credit scoring formula. That portion contributes 30% of your scores.

Different Impact for Those with Lower Debt Balances

Having utilization rates below 10% means that you are minimizing your reliance on revolving credit. You represent a borrower least likely to default.

Closing accounts would likely lower your scores. This is primarily due to your curtailing the credit histories of seasoned accounts that you have maintained for many years. The length of your credit history comprises 10% of credit scoring inputs. Instead of closing unneeded accounts, some people find that their available credit has been slashed by their lenders due to the tightening credit markets.

Conventional wisdom and most published reports would suggest that lowering your credit limits on existing revolving accounts would lower your scores, since it could cause a slight increase in your utilization rates if you carry light debt balances on credit cards. A recent Fair Isaac study initially appeared to counter this belief.

If we could hold all other conditions constant, we would expect that a reduction in available revolving credit would either have no impact on an individual’s FICO score or would cause it to decrease. In reality, the information on credit reports seldom stays fixed or constant. Our research shows that an individual’s score may go down, go up, or stay the same after the lender reduces a borrower’s credit limit or closes the account.

This study confirmed that most of the cardholders that experienced credit limit reductions actually had good credit scores. Of these cardholders, a surprising percentage experienced slight increases to their credit scores rather than decreases when their credit limits were cut. However, Fair Isaac spokesman Craig Watts said that these increases were attributable to other factors.

The conclusion is that if you have higher debt balances, you should favor keeping lines of credit open and try to avoid any reductions in your credit limits. While this may not necessarily be easy, you should at least focus on paying down your balances by sending in much more than your minimum payment requirements. Closing an account or reducing your credit limits would lower your scores.

Alternatively, if you have good credit and low or no debt balances, then you might entertain a reduction in your credit limits if you feel you have too much credit. Rather than closing unused accounts, you should instead consider limiting your overall available credit. While no evidence suggests that excessive amounts of available credit could be a detriment to your scores, closing accounts will have either a neutral or negative impact.

Most importantly, consider your immediate and long-term credit needs. The impact of these credit limit reductions is normally fewer than 20 points, whether it is a lower score for those overextended or a higher score for those with almost no debt. Your actual credit needs may be more important than simply gaining a few credit scoring points. This is especially true if you need deep lines of credit to handle small business contingencies or other emergencies. Most importantly, it is better to experience lower credit limits rather than to lose open accounts that have a long and positive payment history.

What is FICO 08?

A sweeping update to FICO based credit scoring models became known as FICO 08 given that it was being rolled out to credit bureaus in 2008. However, credit bureaus were reluctant to adopt the changes. The reason was that they were trying to promote their own VantageScore products as a way for reducing their reliance on Fair Isaac.

Why Was FICO 08 Needed?

Fair Isaac Corporation was under pressure from lenders to make improvements to FICO scoring models. Much of this pressure was due to rampant gaming of the system by borrowers that were artificially inflating their credit scores.

By getting listed on a seasoned account held by a complete stranger, a borrower could gain many points on their credit scores when the lender reported the authorized user account to credit bureaus. FICO 08 served to limit such practices, which became known as piggybacking.

FICO 08 resolves 2 related needs. Lenders needed to adequately evaluate borrower risk by eliminating obvious and artificial means of inflating scores. Consumers still needed to be able to help an immediate relative, such as a spouse or child, by extending credit as an authorized user. FICO 08 preserves this opportunity while curbing abusing piggybacking practices.

FICO 08 also recognized that consumers were being harshly punished for a single delinquency that could have been a mere oversight or lost payment rather than an indicator of financial distress. A single late payment now has a milder negative impact. Conversely, multiple and severe delinquencies will have a more detrimental impact on credit scores.

Experian Last to Adopt FICO 08

With Equifax and TransUnion each updating their scoring models to include FICO 08 changes, Experian was forced to follow in their footsteps. Lenders had spoken and they wanted the updated scoring products. Experian faced being the “odd man out” by failing to include the changes.

Experian’s conversion to the FICO 08 scoring update became effective on August 1, 2009. This was a significant event for Experian given their legal challenges to Fair Isaac over the past couple of years.

What we are finding is that market forces determine what credit bureaus have to offer. If the lenders all voice their desire for a certain product, then the credit bureaus must comply in order to remain competitive. Otherwise, they face being cut out by the bureaus that meet lender demands.

What we do not know is if this will sign a future death warrant for VantageScores, or if credit bureaus will remain vigilant in their efforts to break away from Fair Isaac. What we do know is that Fair Isaac has at least bought more time as it further cements itself as the leader in risk scoring of consumer credit.

Credit Limit Utilization

First of all, you should understand the root cause of the problem. A full 30% of your credit scores depend on factors that directly depend on your credit balances. The more debt you have, the more your scores may drop. Of course, it does get more complicated than that.

A higher balance on an installment loan will not affect you to the same detriment as a high balance on a credit card. In addition to the sheer amount of debt that you have on credit cards and other lines of credit, the formula also takes into account how much of your total credit are you actually using.

Your credit utilization rate is a calculation that shows the percentage of your revolving credit that you have used. A card with a $10,000 credit limit and a $5,000 balance has a 50% utilization rate. If that lender drops your credit limit to $7,000, then your utilization rate just jumped to over 70%.

This can be very difficult for debtors, since it can cause their scores to drop when a lender cuts their credit limits. While many affected cardholders are calling foul on the policy, it is actually justified.

It is true that market conditions have caused the change rather than the consumer initiating the change. However, a debtor should realize that by carrying a debt in the first place, they are vulnerable to market fluctuations.

A drop in the credit score does accurately portray a higher level of risk because that cardholder will face the following additional difficulties:

• First, their other creditors may see the adverse action on that account and follow suit with credit limit reductions of their own, which can further erode the debtor’s financial situation.
• Second, the debtor may find it more difficult to pay off debt through home refinance or equity lines. They may have a harder time transfering balances to other credit cards also. Even if they do, the rates and term of promotional rates will not be as attractive as before.
• Third, the debtor is now much closer to maxing the card out. If they incur an unexpected expense such as a vehicle repair bill, then they could have difficulty paying that bill without going over the limit on their account.

While FICO CEO Mark Greene certainly may have a biased opinion, he did accurate sum up the reasoning behind the FICO model as it relates to credit limit reductions and the credit utilization rate in a recent Bloomberg article:

It’s not obvious to me that having the score change because of limit cuts is the wrong thing. The bank’s action may signal a riskier environment and the view that you are a riskier consumer.

It is indeed true that the changes made by creditors do adversely affect the credit scores of debtors. FICO is still a reasonably accurate measure of this risk. As long as a household carries unsecured debt balances, they are vulnerable to whims and business decisions of their lenders. The only true way to protect yourself is to pay off the balances completely.

We already know that we have more than one credit score, since each of the three main credit bureaus have different records about your credit accounts. We also know that each credit bureau maintains more than one score for you (See some of the credit scores marketed by credit bureaus). So what is this extra complication that can make credit scoring so difficult to figure out?

Ten Versions of FICO Scoring Formula

There’s not one formula for calculating your FICO score. There are ten. Each is a “scorecard,” that gives different items in your credit history slightly different weight. Your scorecard depends on where you are in your economic life.

Fair Isaac’s spokesman Craig Watts summed up this topic in an April 2009 interview. Fair Isaac actually supplies ten different versions of the credit scoring model. Each version is internally known as a “scorecard.” Your scorecard will depend on certain demographic facts that place you into a group of peers.

Little is known about what these demographic factors are that determine which scorecard will apply to your own unique situation. We know that some factors such as age and the types of accounts that you have maintained have some influence on which scorecard your credit score would be based on.

One factor that we are reasonably certain of based on previous Fair Isaac responses is bankruptcy. It is generally believed that consumers that have filed bankruptcy within the past several years are grouped together and are scored using the same scorecard formula.

Accordingly, your credit scores will be based on how you are viewed as a borrower in comparison to the other consumers that make up your group. If you are among the least risky of your group, then your credit score will be higher than the vast majority of consumers in your group.

However, your credit scores could still fall below those of other consumers that are members of another group. We frequently see evidence of this when one consumer has a higher credit score than another even though their credit reports indicate the possibility of higher risk.

One particular situation that supports this is an individual whose credit scores dropped when a bankruptcy finally fell off of their credit report. Conventional wisdom would suggest that this is counter-intuitive. However, the likely reason is that the individual was in the highest percentile of scored reports in the bankruptcy group, but found themselves in the middle of the pack or worse once they were transferred to a different scorecard group. They no longer appeared to be one of the most creditworthy based on the new set of peers that they were being compared to.

Certainly the scorecard method of calculating credit scores is not perfect. In many ways, it creates discrepancies and problems in credit scoring that can further reduce faith in the integrity of credit scoring as a means for measuring risk. It also alienates many consumers that sometimes try in vain to make positive changes to boost their scores, only to see their scores drop as a result.

The next time you check your credit, understand that these factors that determine your scorecard can ultimately cause your credit scores to shift dramatically. A positive change could open up lending options and reduce rates, while a negative shift could cause major headaches for you!

Either way, the best option is to understand how each action can affect your credit scores and to make the best decision possible to increase your scores. As far as the scorecards are concerned, that’s really out of your control!

If you have experienced financial difficulties, there is a good chance that your credit has suffered. If you have neglected your credit, you could be missing out on a lot of opportunities. Do any of these scenarios sound familiar?

• Denied a loan
• Paying 25% on a car loan
• Passed over for a job opportunity
• Unable to pass a landlord credit check

Even if you rely mostly on paying cash, damaged credit could affect you in many ways you never thought of such as higher insurance rates. In fact, you could even be denied a life insurance policy simply because you have poor credit.

I will be providing a breakdown of how your credit scores are calculated so that you can identify which records in your credit report are causing the most damage. I will also show you how you can dispute inaccurate items.

Time:

6:00 p.m. to 8:00 p.m. on April 23, 2009

Location:

To register, call Tarin Washington with The Women’s Center at 919-968-4610. Class participants are also eligible to sign up for a free 45-minute credit review session on Thursday, April 30.

(Chapel Hill, NC) The Women’s Center of Chapel Hill is hosting a full slate of financial workshops in honor of Financial Literacy month throughout the month of April.  All workshops will be held at The Women’s Center and are open to both men and women.

Topics will include budgeting, repairing and improving your credit, your legal rights as a debtor, and more.  

Vision Credit will partner with the Women’s Center to  provide free credit reports and scores, as well as a 45 minute session to review and discuss your credit report.  Idividual credit reviews are limited and are by appointment only.  

To make an appointment for your free credit review, contact Tarin Washington with the Women’s Center at 919-968-4610.

Times:  April 14 – 1:00-6:00 pm and April 30 – 10:00 am – 2:00 pm

Location:

Why is American Express Trying to Close Accounts?

American Express is trying to limit its exposure to what could end up being record losses due to widespread credit defaults. Four states have already reported unemployment numbers above 10% and several others are knocking on the door.

Economists still expect things to get worse before they get better, with relief expected to come in late 2010 or even later. While some economists have called this the “Great Recession,” it might more appropriately be noted as a depression. We will not know until much later whether economic conditions will have officially deteriorated to the point that this economic cycle could be a depression.

While some card issuers have been reducing credit limits to reduce their exposure to potential losses, American Express has instead offered an incentive of $300 for certain accounts to be paid off and closed. While American Express is not disclosing how it determines which accounts it is selecting for the offer, there is some speculation that it could be tied to the little known “bankruptcy score” that is maintained by credit bureaus.

Recent Growth

American Express reported it had 65.4 million credit cards in use during 2004. By 2008, that number had jumped to 92.4 million accounts. While American Express was very successful at achieving rapid growth, it also may have overextended itself.

Some economists predicted an economic downturn, noting that a correction was needed in response to hyperactive housing markets and out-of-control mortgage lending. However, few could have anticipated that the economy would reach such disturbing levels.

American Express is making the offer at a time in which most other card issuers are also pulling back. Fortunately, American Express is providing an incentive and a choice for cardholders. Other card issuers have not been so generous.

Effects on Credit

If you take American Express up on their offer, there will be some impact on your credit score. Once the account is closed, it will benefit your credit history less and less as time goes on. The effects will be worse for someone who has held the account in good standing for many years. Accounts held less than 2 years would have little impact upon closing. The length of your account history is part of a 10% component of your credit score calculation which measures length of credit history.

Second, your credit score will benefit from having paid off the balance. If you paid cash to pay off the account, this will boost your score by reducing the total outstanding debt, which comprises 30% of your credit score.

If you transfer the balance to another credit card, then this will have very negative consequences. Not only will you take away the long account history that you have established by closing the account, you will also experience an increase in your credit utilization rate. This can cause your score to drop many points.

Should you Take the Offer?

There are several things to consider before deciding whether to take the offer. First, how will it affect your credit. If you have lots of outstanding debt, then the impact could be very negative. On the other hand, if this is your only balance and you pay if off with cash, it could benefit your credit.

Another consideration is your cash reserves and credit needs. Draining your savings and eliminating a line of credit could give you fewer financial options if your income situation takes a turn for the worst. Investment challenges and job losses are key events that could necessitate that you keep a buffer in your finances. Savings and credit are two key tools that allow you to maintain options.

Also, if you have come to depend on the rewards associated with the account, then you would lose those if you closed the account. In the end, consider your situation and do what will benefit you the most.

(Raleigh, NC) Our next credit workshop will be held at the South Wilmington Street Center in downtown Raleigh. This 3 hour class is a component of the Ready to Rent workshop series provided through the Wake County Supportive Housing Program.

Time:

9:00 a.m. to 12:00 noon

Location:

The Ready to Rent program is a workshop series that is geared toward residents that have had credit challenges in the past that may be preventing their acceptance as a tenant. If you or someone you know could benefit from a credit improvement and budgeting course, this is the type of program that can help them better fulfill their tenant responsibilities. In addition, participants learn about:

• landlord responsibilities
• how credit works
• how to improve their credit
• how to budget

Some subsidized housing programs in Wake County strongly encourage applicants to complete this course if they have previous problems with eviction.

To register, contact Jimmie Watson with Wake County Human Services: 919-856-5710

FICO scores are calculated using a secret formula developed by Fair Isaac Corporation. It is calculated based on the credit records that are individually held at each of the three main credit bureaus. Different creditors tend to report items to certain bureaus (not necessarily all 3), so your actual information likely is different from one bureau to another.

Lenders use FICO scores almost universally as a benchmark for establishing their own in-house lending guidelines. In many cases, your application immediately falls within a class of other applicants with matching credit scores.

Experian has provided FICO scores to clients willing to pay their fee. However, effective February 14, 2009 Experian solidified its dispute with Fair Isaac by refusing to extend their agreement. Consumers may no longer obtain their FICO scores based on their consumer data maintained by Experian.

Assuming that Experian does not reverse course, you may only get a true FICO score from Equifax or TransUnion. You may obtain a score from Experian, but it is a relatively useless VantageScore or PLUS Score.

These tend to be indicators of your score rather than a meaningful number. In fact, you might be mislead by a high VantageScore, since it uses a different range than FICO scores utilize. Your lenders may still obtain your Experian FICO score, but you cannot.

Most consumers do not realize how many credit scores they actually have. You might be surprised at the number of credit scores that estimate your creditworthiness. In addition, you also have bankruptcy scores and insurance scores that rate your insurance risks. Even banks utilize secret scores to measure how profitable you are to them as a client!

Buying your credit score can be educational and may allow you to make changes that tend to increase your credit scores. Just make sure that you do not put too much trust in that score–it may mean nothing to your lenders.