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Credit counts

Employers, landlords are among those with an interest in your rating

By BILL WHITE
Anchorage Daily News

March 13th, 2005 - Loan officers aren't the only people looking at your credit score these days when deciding if they want to do business with you.

Some landlords use the scores to screen tenants. Employers to screen some job applicants. Insurance companies to decide who gets coverage.

Yet few consumers understand what credit scores are, how the scores affect their lives or how seemingly well-intended acts can send their scores plummeting.

Personal finance writer Liz Pulliam Weston notes: "Many people are getting really bad advice about credit scores from some people who should know better, including mortgage and real estate professionals."

Weston recently wrote a book, "Your Credit Score," that provides advice on how to understand, fix, improve and protect your three-digit credit score.

She has written on money matters for the Los Angeles Times and currently writes a syndicated column as well as an online column for MSN Money. She appears weekly on CNBC's "Power Lunch" program.

She said she wrote her book "to give people a resource they could use to make a real difference in their finances and that would help them qualify for better terms and lower interest rates on their loans."

Weston, a former Anchorage Daily News reporter now living in the Los Angeles area, recently discussed how credit scores work and what consumers can do to improve theirs. Excerpts follow.

Q. What are the key determinants of a high score? Of a low score?

A. Credit scores are designed to predict your risk of default, so it's not surprising that the biggest chunk of your score is determined by your payment history. If you've been late with a payment or reneged on a debt in the recent past, the scoring model figures you're more likely to do so in the future.

The people who tend to have the best scores are those who use credit, but do so responsibly. They pay all their bills on time, all the time. They don't max out their credit cards or even come close. They don't apply for credit they don't need. To get the absolute best scores, you need to use both revolving debt, like credit cards, and installment debt, like a car loan or mortgage.

The people who have the worst scores are those who have lots of unpaid debts or a recent bankruptcy followed by more late payments.

Q. How do lenders use credit scores?

A. Most lenders use the scores in combination with other information to determine your creditworthiness. One example: The leading credit scoring formula, the FICO, doesn't use income as a factor, but that's something most lenders want to take into account. So they'll look at your credit score as an indicator of your risk of default -- the lower the score, the more the risk. But many will also look at your outstanding debts or credit limits in relationship to your income to see if you look overextended.

Other factors lenders, particularly mortgage lenders, often consider include the stability of your employment and how much of a down payment you're making on the purchase.

Q. You say that lenders aren't the only users of credit scores, but that insurers, employers and landlords use them, too. How are these others using credit scores, and is that a fair use of the information?

A. Landlords, like lenders, want to make sure you're going to pay your bills, and often use credit scores to gauge the risk you'll stop paying rent and they'll have to evict you. Most people can understand that relationship and don't have a big problem with landlords using scores -- unless, of course, they're the ones who can't get an apartment because of it.

Employers using credit data also can make sense, when the job involves handling cash or executive responsibility for finances. Employers typically get the whole credit report, rather than a score. Some employers recently have abandoned the practice, though, because they say bad credit really isn't a good predictor of who might be a thief. The government is still a big believer in pulling credit reports on its potential employees, however, particularly when there are any security clearances involved.

Many people have a bigger problem with insurers using credit information to determine who gets insurance and how much they pay. Insurers say they've found an extremely strong relationship between people's credit problems and their propensity to file claims. Nobody can really explain why, and that's what unnerves some consumer advocates. The advocates are also concerned that credit scoring is being used as a proxy for factors the insurers are otherwise prohibited from using, such as race or income. Their worry is that minorities and people with low incomes may have worse scores, but no one really knows for sure.

Q. What would you consider a golden score? How about a problematic score?

A. Lenders have different criteria, but if your FICO scores are over about 720, you should get the best rates and terms.

Anything below 620 is usually considered subprime; it will be tough to get credit from mainstream lenders, and when you do find a lender you'll pay very high interest rates compared to what people with good credit pay.

In between are mediocre scores. You'll get credit fairly easily, but it will cost you.

Q. Give us an example of how a low score costs a consumer money.

A. I have an extended example in the first chapter of the book using two women, one who has a 750 score and one who has a 650 score. The second woman pays significantly more on her credit cards (an average of 19.9 percent, compared to 9.9 percent for the woman with the better score), on her auto loans (8 percent on average, compared to 5 percent) and on her mortgage (7.375 percent, compared to 5.5 percent). I got the rates from experts on credit card, auto and mortgages rates.

I figured over a lifetime the woman with the mediocre score was paying nearly $300,000 more in interest. If she'd had that money to invest instead, she could have built up a nest egg of about $2 million, assuming 8 percent average annual returns.

Q. You write that people have many credit scores and they change all the time. Explain that.

A. The leading scoring formula is the FICO, but there are dozens of other models and variations, some of which have very specific uses -- like the scoring system designed to predict who will default on their cell phone plans.

Even with the FICO, you'll see variations, because the FICO is based on the information in your credit reports. That information not only changes all the time, but differs depending on which credit bureau furnished the report.

The Big 3 credit bureaus -- Equifax, Experian and TransUnion -- are private businesses that typically don't share information, so you can have accounts and other information show up on one or two reports but not on all three.

That's why mortgage lenders tend to pull your FICO scores from all three bureaus, and then use the middle number to determine your rates and terms.

Q. When a store approves a credit-card application at the cash register, what are they checking to grant such instant credit?

A. Usually they're just getting your credit score, and nothing else.

Q. What's the best way for young adults to establish credit and build a good credit score?

A. The easiest time to get an unsecured credit card is when you're still in college. If that's not an option, start with a gas or department store card, or consider a secured card, which gives you a credit limit equal to the amount of cash you deposit at the issuing bank, typically $200 to $1,000.

You don't want to apply for a bunch of cards at once. Let at least six months go by between applications. You can build a pretty good score with one or two major credit cards (Visa, MasterCard, Discover, American Express) and a gas or department store card.

Use the cards regularly but lightly, and pay off your balance in full each month. You don't have to carry a balance or pay interest to build a good score. You also never want to max out your card or even come close -- keep your charges to no more than about 30 percent of your credit limit.

An installment loan, like a car loan, can help you build credit as well. Just make as large a down payment as possible to ensure you don't wind up owing more than the car is worth.

Finally, but importantly: Always pay your bills on time. I recommend setting up automatic payments so that at least the minimum amount owed is whisked automatically from your checking account each month. This system ensures that you're never late, even if your life gets busy.

Q. Is it bad to have a lot of credit cards?

A. Any time you apply for credit, you risk dinging your score. That's why I typically advise people to avoid signing up for those instant, "get 10 percent off now!" deals at retailers. Most of us have more than enough cards and we don't need another one to keep track of.

But it's also not the end of the world if you've already opened a lot of cards. Many of us have. Some people get their credit scores and freak out when they read that the reason their score isn't higher is that they have "too much revolving credit." They rush out and start closing accounts right and left, not realizing a couple of things.

One is that they probably have a pretty high score if they got the "too much revolving credit" notation. The scoring system is set up so that you have to be given some reason why your score isn't higher, but the better your score, the less significant those reasons are. Even if you could somehow fix the "problem," it probably wouldn't improve your score that much.

Second, people don't realize the damage is already done. People think they're making things better when they close accounts, when in fact closing credit-card accounts can't help your score and might hurt it. The score wants to see a big gap between your credit limits and the credit you're using; closing accounts narrows that gap, which can be bad for your score. Also, you want to avoid closing your oldest accounts if you can, because the longer your credit history, the better.

Business editor Bill White can be reached at bwhite@adn.com or 257-4311.