You finance every purchase that you make in life. When you borrow money to purchase something, you pay interest on the balance you owe. When you pay cash, you lose the potential interest through investment on the cash itself. A smart investor leverages OPM (Other People Money) to make more money.
Your credit score (FICO) plays an important role in your financial life. The lenders use credit score to determine your credit worthiness, how much money they are willing to lend you. There are many misconceptions out there about how credit score works. Just as in sports, you need to know the rules in order to win the game. Let’s look at how credit score works and learn how to improve your credit score.
Anatomy of Credit Score
The following is the break down on how your credit score is calculated
35% - Payment history and/or past delinquencies
30% - Revolving debt ratio
15% - Average age of file/length of history
10% - Mix of credit (installment, revolving, etc.)
10% - Inquiries
Myths: Always pay your credit card balance in full
Facts: No balance means no payment history
First of all, be sure to pay your bills on time, especially those revolving debts such as mortgage and car payments. The lender will consider you high risk if you’re consistently late in paying your mortgage or missing payment(s). Take advantage of automatic payments for these revolving debts. Although credit card bills are weighted less, be sure to pay them on time too.
Secondly, you want to use your credit cards and leave small balance on the pay cycle to establish payment history. Installment payments such as student loan can also affects the payment history.
Myths: Always max out the credit card with the smallest APR first before using other credit cards
Facts: Your credit card balance should always be less than 30% of credit limit
Let’s say you have 3 credit cards with $10,000 credit limit each (and no balance) and you’re planning to spend $4,500 on vacation.
Scenario #1: Put $4,500 on one credit card and leave the other two at zero balance. Your debt-to-credit-limit ratio on the first credit card is at 45%. Any ratio greater than 30% is a red flag in the lender’s eyes and they will consider you as at a higher risk.
Scenario #2: Put $1,500 on each credit card. Your ratio is now 15% on each credit card. This will not raise any flag in lender’s eyes.
Be sure to keep your balance to be 30% or less.
Myths: Close your old credit card when you apply for a new one
Facts: Never close your Visa, Master Card, AMEX, or Discover
The lender looks at average age of file/length of history. The longer it is, the better it is. So, never close your credit card. Simply use them once every six month to keep payment history.
Myths: Each inquiry will hurt my credit score
Facts: Six inquires in the last 90 days is ok
Let’s say you have 4 credit inquires in January, 1 inquiry in February, and 1 inquiry in March. When it comes to April, the lender will only see 2 inquiries (since the 4 inquiries in January will drop out).
If you have to apply for multiple credit cards to increase your available balance, do it within 3 days. The lender usually consider these inquiries as “soft pull”
Each credit inquiry over 6 will decrease credit score by a small amount (less than 10 points each).
Myths: My mortgage broker can use the credit report I obtain from my annual free credit report
Facts: Your annual credit report is weighted differently than the lender’s credit report
Tips: You want to see the same report as what the lender sees. Don’t be surprised if you find out that your free credit report’s score is off by 30-40 points comparing to the one that the lender pulls. It typically costs $25-$30 to pull your credit report from lender’s eyes. It’s worth your investment to get an accurate credit report to see which loan works best for you and the lender usually requires a fresh one.
Remember, you’re borrowing hundreds of thousands, if not millions of dollars. Don’t let the $25 charge hinder you from getting the best loans/options.
Summary
If you follow these rules, you will likely to improve/maintain a high credit score. Please contact us at info@team803.com if you have further questions on how credit score works and any tips to increase your ability to borrow money.
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