First Connecticut Mortgage Newsletter June 2006

Why Is Your Credit Important: Part Five
Your Credit Score: It's All in the Mix

Brought to you by Reynold Nippe

The mix of your credit accounts for 10% of your credit score. Think that's not too much to get excited about? Think again. Sure, 10% seems to be pretty negligible when you consider that Payment History accounts for 35% and Amounts Owed counts for 30%, but frequently, just a few points can make all the difference as to whether or not you get the loan. Just like those annoying standardized tests you took in school, every single point makes a difference. Plus, if the highest credit score you can get is 850, 85 points come from this factor.

What does "mix of credit" really mean? Your mix of credit is made up of the different types of credit accounts that appear on your credit reports. Essentially, there are three different types of credit represented. They are:

1. Revolving Accounts
2. Installment Accounts
3. Open Accounts

All accounts that appear on your credit report that really matter fall under one of these three categories. As a point of information, debit cards are not true credit cards. Using a debit card is basically the same as writing a check. As such, debit cards have no impact on your credit score-neither positive, nor negative.

Not all creditors report to all three bureaus, so if you have a car loan that you've been paying on time for 2 years, and it is not reporting on one of your reports, it is actually hurting your score because you are not receiving points for a positive credit relationship. Make sure that ALL positive accounts are reported to all three bureaus, if not, call the creditors, or write them a letter and send a copy to the bureaus not reporting it.

An In-depth Look at the Accounts that Count

The credit scoring system has been programmed to use the different types of accounts to grade us. We all need to prove that we can manage different types of credit with different rules and agreements. Like, the reason we DON'T want to pay off an auto loan before the time is up is because auto loans (installment loans) are there to show the scoring system that consumers can make a $200 payment on the 5th of each month (on time) for a period of 3 years. If we pay it off before the agreed to 3 years, then we will lose the potential credit score reward at the end of the loan. Once we prove ourselves, we will have the best opportunity to maximize our credit scores. Let's take a look at the different types of accounts:

1. Revolving Accounts
   Revolving accounts require a different amount of payment every month with the minimum amount you are obligated to pay being a percentage of the amount owed. FYI, recent changes in legislation enabled credit card companies to increase the minimum monthly payment from 2% to 4% of the total debt obligation. Interest is charged on the remaining balance, which is what makes the credit card business so profitable. Examples of revolving accounts are as follows:
   
   
   • Major Credit Card Accounts: Examples of major credit cards include bank issued Visa's and MasterCard's and non-bank-issued credit cards such as Discover and AMEX. Accepted virtually anywhere, both bank-issued cards and non-bank-issued credit cards are very common entries on credit reports.
     
     
   • Secured Credit Card Accounts: A secured credit card is like a secured loan; the consumer deposits money into a savings account as collateral for a line of credit. The card is the same in appearance as a major credit card account and offers the same convenience and charging privileges as a traditional unsecured credit card. Secured credit cards are ideal for applicants who intend to build or re-establish their credit history, especially after bankruptcy.
     
     
   • Department Store & Gas Company Credit Cards: These are single purpose credit cards that are accepted only by the merchant who distributes them. As such, department store credit and gas cards are considered to be low quality credit and can drag down the score. The credit scoring system is programmed to grade us as desperate if we have to resort to a third party for financing! Sorry, I didn't make the rules. One possible exception is Sears, which holds its applicants to higher credit standards. As a word of caution, when shopping in department stores, avoid the allure of teaser deals that offer 15% off a single day's purchases or deferred billing if you apply for their store credit card. The few dollars you will save will not justify the strike against your credit score for adding a new, lower quality line of credit.
     
     
   • Home Equity Lines of Credit (HELOC): Homeowners today will find easy access to home equity lines of credit or HELOCs. Sometimes these types of accounts are reported to the credit bureaus as revolving accounts. NOT GOOD and unfair because as we all know, this type of loan is secured by your home, right! What you need to know is 1) if you open a home equity line of credit, it is best if you open the line over $40,000, and 2) if the credit report is reporting a HELOC as a revolving account, then write to the bureaus immediately to get it changed from Revolving to Installment, or last case scenario, "Other". Why, because 30% of your score is made up of revolving debt, and the rule is very clear, if your balance is over 50% of your available limit, your score will go down by 30+ points. If you max out a revolving account, your score can go down by 80+ points. We all know that the reason we get a HELOC is to remodel, refurnish, pay off debt, etc. bottom line is we almost ALWAYS max out a HELOC.
     
     
2. Installment Accounts
   Installment accounts carry a fixed payment. Examples of installment accounts are auto loans, student loans, home equity loans, signature loans and fixed-rate mortgages. Paying a mortgage late can cost you 50+ points immediately, and will take you years to make up.
   
   
3. Open Accounts
   Open accounts are accounts that have no limit and they must be paid in-full every month. Examples include, but are not limited to, utility bills, cellular phone bills and medical bills. What might be surprising is that utility companies can check credit reports to determine whether a deposit is required to initiate service. Additionally, some cellular phone companies do report to the credit bureaus.
   

The Perfect Mix of Credit

There really is no boilerplate perfect mix of credit, but here are some great guidelines based on where you are with your credit history.

• For new credit users (1-2 years): 1-2 credit cards
• For semi new credit users (2-3 years) 2-3 credit cards, and an auto loan
• For seasoned credit users (3-7 years) 3-5 credit cards, an auto loan and a mortgage
• Anything beyond 7 years - As much good credit as you want!

Just like the perfect pot of minestrone, a little bit of something can add depth and interest, while too much can really detract from the overall mix. It's the same with credit. The reason why it is so important to be picky about the lines of credit you establish is because once you open a line of credit, it is on your record for a very long time.

The most important aspect regarding your mix of credit is to have as much high-quality credit as possible, with a good blend of revolving and installment debt.

Important Note: There are three credit bureaus and they each generate a separate report on you. Not all information will be reported to all three bureaus which will result in three different scores. Each bureau will examine the types of credit listed on your report and establish a point system for those types of credit that will make up the 10%. By understanding how the scoring system looks at each type of credit and the amount of that type of credit you have, you can improve your score. Here's how:

5 Steps to Improving Your Credit Mix:

Step 1: The first step is to have a complete picture of your current credit situation by ordering your credit report and score for all three national credit bureaus, TransUnion, Equifax and Experian. You should get your score from all three bureaus for two reasons. First, each bureau may have slightly different information about you depending on which companies have reported to them on your accounts. Second, many lenders, especially mortgage lenders, look at all three of your FICO scores to determine whether to grant credit - for everything from a car loan to a home loan to a credit card or a cell phone. Do not allow a creditor to pull your reports because you will lose points for a hard inquiry.

You can pull all three credit reports and scores for $1.00 at www.privacyguard.com. Please be sure to read the terms and conditions of the Privacy Guard Agreement.

Step 2: Sort the types of credit by using the above information to determine which type of account it is.

Step 3: If you don't have credit cards, or enough credit cards, get them. This is probably the most important advice I can give you. If you can't walk into your bank and be approved for a major credit card now, then apply on-line for a secured credit card. It usually takes 24 hours, the denial rate is extremely low, and once you start using the card, your score will go up. Keep your balances below 30% of the available limit, and pay the bill on time every month. Do not close credit cards unless under extreme circumstances, such as identity theft. It will hurt your score. Even if you have third party finance cards open now, the damage has already been done. Just move forward by establishing higher quality credit accounts. Here are two links of on-line secured credit card companies that have programs specifically for helping consumers rebuild and/or establish credit: www.orchardbank.com and www.firstpremierbankcards.com.

Another way to get a credit card account added to your credit report is to be added to another person's credit card as an authorized user. Although creditors are becoming savvier to this technique, it still works. Make sure that the account you're being added to belongs to someone that you trust, has NO negative history reporting at all, has a balance under 30% of the available limit, and is at least 2-3 years old.

Step 4: Ensure that all of your positive accounts are being reported to all three credit bureaus. If not, write a certified letter to the creditor and to the bureau to make sure that the account gets listed immediately.

Step 5: If you have a HELOC showing as a Revolving account, write to the bureaus and ask them to change it to "Installment" or "Other." If they don't make the change the first time, try again. You will eventually prevail and your score will show the reward immediately.

Some Good Pointers

The following tips will help you maximize your points for the Mix of Credit factor:

• Having a mortgage: Mortgages are considered higher-quality credit. Consumers with mortgages are perceived to have much to protect when it comes to their credit and their debt obligations. They have an incentive to pay their bills on time. Also, homeowners tend to have a built-in safety net with easy access to HELOCs.
• Avoiding Third Party Finance Lenders: These are department store or furniture store credit cards. They are perceived as lenders catering to only the desperate and are considered the black sheep of the credit world.
• Don't have too many credit cards but don't have too little: Follow the guidelines I've outlined above. A little credit, used prudently demonstrates a proven track record, while too many lines of credit can make you look like a kid in a candy store. Also, be careful how you apply. If you apply for several revolving accounts at once, your credit profile will be flagged and your score will go down. To the scoring system you appear to be in financial trouble. Always apply at least a month apart.
• Financing a Car: Auto Financing is a great way to prove your credit worthiness and will help your mix of credit. If you do not have an auto loan on your profile, and cannot get an auto loan at this time, a cosigned loan is always a good option.
  

In Conclusion:

The right mix of credit can add much-needed points to your credit score, which will save you hundreds, if not thousands of dollars a year in the way of higher interest rates and fees. Choose your avenues of credit carefully, both in the types of credit you carry and in the amount of credit of any one type that you carry. In doing so, you will be able to maintain the highest credit score possible, and you will enjoy favorable rates of interest and credit opportunity. Keep your eye fixed on the prize and know that, in the long-run, it is so worth it!

All the best.