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UNDERSTANDING CREDIT

Primary Factors Impacting Your Credit Score:

1. Payment History:

     a. Payment History is the percentage of payments you've made on time, and has the greatest impact on your credit score

     b. Your record of on-time and late payments will continue on your credit report for 7 to 10 years, although the past 24 months create the greatest impact.

     c. Late or missed payments are typically reported by lenders if you have missed your due date by 30 days, and even one late payment can impact your credit

     d. Lenders want to see that you reliably pay your debts on time

     e. How to Improve Payment History:

          i. Pay on time.  Always.

          ii. Set up payment reminders

          iii. Consider enrolling in automatic payments (but be careful not to overdraft your bank account!)

          iv. If you miss a payment, do your best to get back on track.  Missed payments won't hurt you forever, so the longer you can establish a history of on-time payments, the better off you will be

 

2. Credit Utilization:

     a. Credit Utilization is the percentage of total available credit limits that you're currently using and, in connection with the total amount owed, has a high impact on your credit score

     b. Credit Utilization is calculated by taking your reported open credit balances and dividing by your total credit limits.  For example, if you have total credit limits on your open accounts of $10,000.00, and your total balances add up to $2,000.00, then your credit utilization is 20%.  Even if you pay your balances in full each month, spending on your credit card will generate a balance, which will be reported and factored into your credit utilization.

     c. Ideally, you want to show that you are only using a portion of your available credit.  There are no hard and fast rules, but experts recommend not using more than 30% of your available credit.

     d. Lenders want to see that you can use your credit and manage it responsibly

     e. How to Improve Credit Utilization:

          i. Lenders look at overall utilization, so transferring balances from one card to another will have no impact.  The most effective way to improve credit utilization is to pay down overall debt.

          ii. If an account is in good standing, consider keeping it open even if you aren't using it.  Closing credit cards may lower your score by decreasing your total available credit. If a card is sitting dormant for too long, the credit card company may close it, so be sure to use cards at least once in a while (and pay off the charges!) to prevent this.

          iii. If you have low total available credit, consider paying the charges as you go, so that when the monthly statement comes out, it will show $0 or a low balance, and thus a lower reported utilization rate.  Remember, you don't HAVE to wait until a statement is issued to make your payment!

          iv. Don't open a new card simply to obtain additional credit – opening a new account will add a hard inquiry to your credit report, which will have a negative impact (see below).

 

3. Length of Credit:

     a. Length of Credit (or age of credit) is the average length of time since your credit accounts or loans have been open, and it has a moderate impact on your credit score.  Remember that accounts typically stay on your credit report for 7 to 10 years after closure.

     b. In addition to the average age, lenders will typically consider the age of the oldest account and the newest account on your credit history.

     c. Lenders want to see that you have an established credit history and are able to manage your credit over a long period of time.

     d. How to Improve Length of Credit:

          i. Consider keeping your oldest accounts, and be thoughtful when opening new accounts.

          ii. Although new accounts can come with promotional perks and special offers, they can also decrease your credit score by lowering the overall length of your credit, as well as adding hard inquiries to your credit report (see below).

 

4. Credit Inquiries:

     a. A Credit Inquiry (or "hard inquiry") is generated when a lender checks your credit information because you've applied for credit with them.  These hard inquiries stay on your credit report for up to 25 months.  While a single hard inquiry will have a low impact on your credit score, multiple hard inquiries within a short period of time will have a larger negative impact and may prevent you from obtaining credit or qualifying for the best available rates.

     b. Other inquiries, such as when you check your own credit report or score, are known as a "soft inquiry" and these do not affect your credit score.

     c. How to Approach Credit Inquiries:

          i. Only apply for the credit you need, to avoid generating multiple hard inquiries within a 2 year span.

          ii. Prior to applying for a mortgage or loan, avoid generating new hard inquiries.  For example, applying for multiple credit cards may lower your credit score, which may prevent you from qualifying for the most favorable mortgage and loan rates shortly afterward.

          iii. When looking for a mortgage or auto loan, try to limit your rate-shopping to a 30-day period.  If you do, it's likely those applications will only count as one hard credit inquiry with respect to most credit score calculations.  However, each application on a credit card will count as a single hard inquiry.

 

5. Open Accounts:

     a. Open Accounts are the accounts that are reported as open by lenders to a credit reporting agency

     b. Lenders will consider both the number and the mix of accounts you have, including (but not limited to) personal loans or lines of credit, student loan, auto loan, mortgage, and credit card accounts.

     c. In general, your open accounts have a relatively low impact on your credit score.

     d. Lenders want to see that you are capable of managing a variety of accounts.

     e. How to Improve Open Accounts:

          i. Consider your mix of accounts, and try to have multiple types.

          ii. Remember that this is a small part of your credit picture, so avoid opening accounts solely for the purpose of having an account mix – only apply for the credit you need.

 

6. Bankruptcy-Specific Issues: 

     a. When you file bankruptcy, your creditors will stop reporting all discharged / dischargeable debts.  If debts are being reported improperly after you have filed your bankruptcy, reach out to your attorney for help resolving this!

     b. In a chapter 7 bankruptcy, if you reaffirm on a debt (typically a home mortgage or car loan), creditors typically resume credit reporting on that debt (although not all creditors resume reporting - it's a good idea to check with the creditor on their procedure at the time you are reaffirming).  So, in many cases, reaffirming on a secured debt can be a way to jump-start your credit rebuilding process, but this will only help if the creditor does in fact resume credit reporting.  Consult with your attorney on whether it is advisable to reaffirm on a particular debt - this is a pretty fact specific decision to make.

     c. Once your discharge order is entered and your case is closed, you will be eligible to incur debt without any bankruptcy restrictions.  Keep the information above in mind if/when you incur debt, and use this knowledge to your benefit to help build your credit back effectively.  Some tips:

          i. If you are having trouble obtaining a credit card, try talking to your local bank or credit union about getting a secured card. This is where you put money on deposit as the collateral for the card, to give the bank assurance that if you fail to pay, they can swipe those funds and pay off the card.  It may be easier to get a secured card than other types of loans or credit cards.

          ii. Rebuilding credit after bankruptcy is much like starting from scratch, so you will very likely have low overall limits.  Never charge anything that you aren't able to pay in full from separate cash in your bank account, and pay the charges as you go to keep your utilization low.

7. Common Misconception

     a. I have heard people say that it's good to carry a balance on cards and pay the interest, because that helps build credit faster.  This is a myth!  I'm not sure where it originated, but it sounds like the kind of thing a bank charging interest would make up to pad their profits (maybe that's just my cynical mind at work?). 

     b. In any event, please know that you are working against yourself by carrying a balance, and it's worse if the debt has a high interest rate.  Check out this blog post about interest for more details on how interest works - basically, if you are not paying your balances in full by the time they are due, you are paying potentially huge amounts of interest, and this is NOT helping you build your credit any faster.

     c. Follow the tips above to improve your credit, and don't fall for myths that are holding you back and costing you money!

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