How Borrowing More Raises Your Credit Score
John Wasik, the author of “The Debt-Free Degree,” “Keynes’s Way to Wealth“and 13 other books recently received notices by his credit card companies that his FICO score changed.
At first, he was somewhat alarmed. Normally, he didn’t pay too much attention to his credit score, which is measured by the FICO. He kept a close eye on all of his spending, but he was always concerned about changes. He had been the victim of identity theft — twice. The good news was that his FICO score went up. In fact, it was nearly perfect (850 is the top mark).
He thought: “Should I start bragging to my neighbors and family?”
Actually, his FICO went up because he borrowed more and his payments were all on time. His minivan was recently totaled, and he had to buy a new car and took out a loan. He wasn’t planning to buy a new car, but the loan offered by the dealer was interest free. In the credit world, borrowing more can raise your FICO score.
But there are so many other factors to understand, you need to drill a little deeper in order to maintain a good credit record. Merchants would love to extend more credit so that you will spend more. There’s good credit and bad credit, and you need to know what’s most important in the borrowing game. The better your FICO, the lower the rate on finance charges. That’s not always true, although it’s a good rule of thumb.
Those who are seen as bad credit risks are not consistent in paying back their debts and take out lots of credit relative to their income. They are seen as less credit “worthy” than those who pay on time on a regular basis.
While the precise credit scoring formula is a trade secret, FICO says that 65% of the score comes from how much you owe and your payment history. The remainder is based on new credit, length of credit and mix of credit. A roundabout way of establishing good credit is to have a variety of borrowing (installment loans, credit cards) for years and keep your payments current.
Here are some other advantages of having a relatively high FICO score, according to myFICO.com:
You Can Get Loans Faster
Scores can be delivered almost instantaneously, helping lenders speed up loan approvals. Today many credit decisions can be made within minutes. Even a mortgage application can be approved in hours instead of weeks for borrowers who score above a lender’s `score cutoff.’ Scoring also allows retail stores, Internet sites and other lenders to make “instant credit” decisions.
Credit Decisions Are Fairer, The FICO Folks Claim
Lenders can focus only on the facts related to credit risk, rather than their personal feelings. Factors like your gender, race, religion, nationality and marital status are not considered by credit scoring.
Credit “Mistakes” Count For Less
If you have had poor credit performance in the past, credit scoring doesn’t let that haunt you forever. Past credit problems fade as time passes and as recent good payment patterns show up on your credit report. Unlike so-called `knock out rules’ that turn down borrowers based solely on a past problem in their file, credit scoring weighs all of the credit-related information, both good and bad, in your credit report.
More Credit Is Available
Lenders who use credit scoring can approve more loans…it allows lenders to identify individuals who are likely to perform well in the future, even though their credit report shows past problems. Even people whose scores are lower than a lender’s cutoff for `automatic approval’ benefit from scoring.
Finance Rates Are Lower Overall
With more credit available, the cost of credit for borrowers decreases. Automated credit processes, including credit scoring, make the credit granting process more efficient and less costly for lenders, who in turn have passed savings on to their customers.
Of course, the industry insists that their scoring system is fair; their self-evaluation is quoted above. That’s not to say it’s perfect, although I’m hardly an expert on the flaws in modern credit scoring.
What you need to do is to monitor your credit report on a regular basis. If you have a credit card that sends you free updates, even better. Correct any mistakes. You have a right to do that at any time and the credit reporting services must update your record. You can also get free annual credit reports here.
An even better credit practice never borrow more than you can afford to pay back and pay all of your credit card bills in full every month. That will not only boost your credit rating, it will keep you from getting into money trouble down the road.