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Why Maintaining Your Credit Score Becomes
Even More Important During the Continuing Credit Crunch
It's always a good idea to be vigilant about your credit
score, but even if borrowing loosens up a bit in 2009, you still
need to do everything necessary to keep your credit score high.
Fair Isaac, the company that created the FICO score, has been
working on a new version of its landmark credit scoring method
that might have serious consequences for you if you're planning
on borrowing for a home or establishing any other new credit in
2009.
The new version of FICO is going to be particularly focused
on your balances, not only on your on-time payment records.
Your top priority under this new system: Get balances down.
Reports say that the new FICO revision will actually allow a
bit of lenience on late payment something that might affect
more than a few consumers with the downturn in the economy.
Obviously, this won't mean that someone can chronically pay
late, but once or twice won't make the same impact as in earlier
FICO versions.
Yet credit utilization essentially the amount of credit
you're actually using relative to your credit limit is a much
bigger deal simply because high balances are so prevalent right
now. From the lender's perspective, high balances mixed with a
tough economy means a higher risk of default among customers.
So what's a good target utilization rate for all your
revolving credit accounts? No more than 50 percent of your
credit limit, and if you can get it significantly lower than
that over time, that's a good plan. So, the lower your credit
utilization, the better your score.
What does that mean for ordinary Americans who don't meet
that under-50 percent goal? It means you shouldn't be applying
for new credit or refinancing for awhile. But because most
lending institutions may continue their strict lending
requirements, you might as well defer borrowing goals in favor
of reforming your credit behavior.
So instead of bemoaning your tougher chances of getting a
loan for a home or a car, why not use the current environment to
launch a credit makeover that will position you for a better
shot six months to a year from now? Some ideas:
You'll need at least a 740 score for the best rates.
You'll often hear that credit scores of 700 and up will get you
best customer status with lenders. You should aim higher. For
the lowest rates and best terms, you need to get your credit
score above 740 (the top credit score, by the way, is 850), so
keep that target in mind.
Budget. If you've never reviewed your spending and
picked out areas where you can cut, you've never done a budget.
Start tracking your spending either on paper or with financial
planning software and start pinpointing what spending you can
shift over to paying off debt.
One more time get those balances down. Get all your
non-deductible debt under 50 percent of your credit line in each
account. Go after your balances with the highest interest rates
first, and once you hit 50 percent... keep trying and get those
balances down further.
Get some advice. It might not be a bad time to sit
down with a tax professional or a financial adviser such as a
CERTIFIED FINANCIAL PLANNER professional to talk about the
way you're going to manage your debt going forward.
Keep an eye on your credit reports. Remember that you
have the right to get all three of your credit reports from
Experian, TransUnion and Equifax once a year for free. You
can do so by ordering them at www.annualcreditreport.com.
Don't order all three of them at the same time, though. By
staggering receipt of each of your credit reports, you'll get a
continuous picture of how your credit picture looks because the
three bureaus feed each other the latest information. You'll
also be able to clean up errors as you find them errors can
drag down a credit score and you'll also keep an eye out for
identity theft. Oh, and by the way, keep in mind that all
"free" credit report sites are not free if they ask
you for a credit card number, remember they're doing that
because they want to charge you. Just go to the site above and
you'll be fine.
Get on time and pay more than the minimum. Yes, we
indicated above that you might get a bit of a break on late
payments with the new FICO system, but that's a break you should
consider only in a dire emergency. Electronic bill payment will
allow you to save on postage while guaranteeing on-time payment,
and the budgeting advice mentioned above will allow you to put a
few more bucks toward getting that loan or credit card bill paid
off.
Once you're paid off, don't close the account. In the
world of credit scoring, closing accounts (even those that have
not had balances for years) is a lousy idea. Lenders want to see
a long record of credit management, and longtime accounts that
you haven't touched in years may actually help your score
because it shows you have some restraint.
April 2009 This column is produced by the Financial
Planning Association, the membership organization for the
financial planning community, and is provided by Don McCarty of
Financial Decision Partners, a local member of the FPA.
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