By FPA member Cathie Restivo, CFP®
Last Updated: October 24, 2011
For those who are considering taking advantage of low interest rates, your Fair Isaac Corporation (FICO) score will determine whether you’ll be able to obtain a home loan and the interest rate you pay on a loan. FICO scores range from 350-850. Lenders today will give the best interest rates to those with 720 (preferably 750) or higher.
First, let’s look at the average negative point deductions for specific activities so that you can avoid them over the next year:
- Bankruptcy: -130 to -240 points
- Foreclosure: -85 to -160 points
- Debt Settlement: -45 to -125 points
- Late payments: -60 to -110 points
- Using too much of your available balance: -10 to -45 points.
Strategies to improve your scores over the next year are:
Use old cards: We were told for years to cut up or cancel old credit cards. Now, it’s better to periodically dust off those old credit cards sitting in a drawer and use them for small purchases. Pay off the balance within a month to avoid interest charges. The key is to show activity on the card, since 15 percent of your score is based on your credit history.
Increase available credit: The old 50/50 rule we used in the past is long gone. Today, creditors want to see that you are using no more than 20 percent of your available credit; less than 10 percent is even better. Since 30 percent of your FICO score is based on the percentage you owe divided by the total amount available, keeping your spending under 20 percent is a great way to increase your credit score.
Pay on time: Sounds pretty obvious, but unfortunately many people think paying a day or two late is no big deal. Thirty-five percent of your FICO score is based on credit history, so paying on time is crucial. As noted above, making one late payment can reduce your score as much as 110 points!
Avoid co-signing for others: This will show up on your credit report and could negatively affect your score if the individual goes over 20 percent of the credit limit or fails to make a payment on time. Just one incident could reduce an “Excellent” rating down to a “Poor” rating, and increase the interest you pay on loans and insurance. Caution: While the new credit card rules require a co-signer for minors under 21 who apply for a credit card, many companies are not adhering to the new rules. Be sure to warn the young adults in your life of the hazards of applying for and misusing credit cards during their early years. A couple of mistakes may prevent them from finding a place to live, purchasing a car, buying insurance at a reasonable rate, or even obtaining a job.
Limit applications for loans or credit cards: Since 10 percent of your score is determined by the number of new applications, inquiries, or credit you apply for, if you don’t need additional credit this year, avoid signing up for new cards or giving approval to anyone to look at your credit score. Just sit tight and gradually watch your score increase.
FPA member Cathie Restivo, CFP®, is the Regional Client Relationship Director/Certified Instructor at LFE Institute, Inc.