Understanding Credit

What is a credit score?

Credit scores are like a snapshot of your current financial situation. Your credit score has many elements that make up the total score, including payment history, amounts owed, length of credit history, establishing new credit and types of credit in use (see graph below). If you currently have negative credit, you can recover with time and eventually improve your credit score. Improving your credit score will improve your borrowing potential.

Trade Lines

You should have a minimum of three to five active trade lines to establish solid credit scores and meet the requirements of most lenders. Trade lines include auto loans, student loans, secured and unsecured installment loans, and credit cards (revolving credit).

Some lenders require at least one credit line for a minimum of two years. Keep credit cards open, even if they are not being used.

Payments

Always make payments on time. Late payments reported on your credit report will have a dramatic affect to your credit score. Time is the only factor that will improve your credit scores after late payments.

If you currently have a mortgage, always pay on time. A late payment on a mortgage will have more affect on your borrowing potential than a late payment on another trade line. Late payments on any trade line will have a negative affect on your borrowing potential.

Credit Cards

Keep credit card balances well below 50% of the credit limit, ideally 30% or less. High credit card balances will have a negative effect on credit scores. Ideally credit cards should be used and paid in full every month.

Collections and Charge Offs

Avoid collections and charge offs on your credit report. Collections and charge offs will have a negative affect on your credit score and some lenders will require you to pay them to be eligible for a loan. If you currently have collections or charge offs on your credit report, you may need to wait to pay these until required by the lender. Paying collections and charge offs will bring them current on your credit report and could actually reduce your score temporarily. Pay these when you have sufficient time for your score to recover. Work closesly with a mortgage specialist to determine if collections should be paid prior to purchasing a home.

Public Records

Avoid public records such as bankruptcies and judgments. Public records can stay on your credit report for up to 10 years after they have been satisfied. Most lenders will require you to satisfy public records to be eligible for a loan.

More Information

For more information on credit scores, go to Understanding Credit and download the free booklet by FICO.