Two years ago, nearly 70 percent of applicants for credit cards received approval. Today, new account acceptance hovers around 35 percent. Far more stringent requirements from lenders mean you must pursue aggressive personal strategies to drive your credit ratings higher.
First, you should rarely (or never) make a late payment because your credit scores will probably sink much lower than you expect. How low? Each late credit card payment will cost you 25-plus points off your credit ratings. A single late mortgage payment will prevent you from qualifying for a new mortgage until two years after the late pay. Next, pay attention to how you use your credit cards. Your habits are analyzed by software that looks closely at your cash flow.
One company, Fair Isaac, develops software used by the three major credit reporting agencies, also called credit bureaus: Equifax, Experian, and Trans Union. The numeric score that determines your credit worthiness is known as a credit rating, a credit score, or a FICO (Fair Isaac CO) score. These terms all have the same meaning. Because each firm emphasizes different aspects of your credit history, the three credit bureaus provide unique ratings ranging between 300 and 850.
According to Experian (and undisputed by the other agencies), the average credit score is 678. To qualify for the best interest rates you need to exceed 740. While all three credit reporting agencies emphasize different parts of your credit history when they determine your FICO scores, there are enough similarities among them to create strategies you can use to raise your credit ratings and keep them high.
Raise Your Credit Scores
We usually think of “cash flow” (how much cash goes out vs. how much cash comes in) in a business context. But it also applies to our personal finances. Fair Isaac software analyzes personal cash flow by calculating how much of your available credit you use. When we first experienced the credit meltdown in August, Equifax issued a notice saying consumers should use no more than 10 percent of their credit limits if they want to improve their credit scores.
So, for example, with a credit limit of $10,000 on an account, Fair Isaac software decides whether you are experiencing a cash flow problem based on the percentage of $10,000 that you use. To raise your credit scores, you never want a balance higher than $1,000 and you want to pay it off as quickly as possible. If you use more than 40 percent of available credit, $4,000 on this account, points will begin to be deducted from your credit score. And maxing out a card can cost you a drastic drop of 100 points, or more, off your FICO score. Prior to the onset of the credit crunch, FICO scores could be improved if balances stayed below 30 percent.
Some financial advisors say all your available credit is added together and the software computes a percentage of that much larger total. It’s a myth; don’t believe it. Every credit card account is evaluated and scored separately. And there are additional hits to your scores if multiple cards carry high balances.
It is to your advantage to get your credit limits set as high as possible on two or three accounts so you have more latitude to use a card without exceeding 10 percent of its limit.
What if you are planning to transfer some of your credit card debt to a new account that has zero or ultra-low interest? Be certain that the balance on the new account does not exceed 40 percent of the account limit. Often, the limit is set close to the total amount of transferred debt. When that occurs, your credit score can drop by 100 to 150 points, moving you from an excellent credit risk down to a subprime borrower. It will take you between 12 and 24 months to fully restore your credit ratings. With much stricter lending policies in effect now, you do not want to be cast into a subprime range. Whatever you transfer, reduce it to 10 percent of the account limit as quickly as possible.
Here are quick and simple things you can do to raise your credit score and keep it high.
- Pay all bills on time.
- Keep account balances below 10 percent of account limits.
- Use credit cards at least once a month to make a small purchase (say $25 at the grocery store); and pay it off immediately.This process tells the analysis software that you have excellent cash flow.
Commit to these actions and watch your credit ratings soar.