June 30th is typically the busiest home closing day of the year. For most home buyers, it is also that time of the year where a credit score is thought of since the difference between a good or bad credit score could mean hundreds or thousands more dollars a year in mortgage payments. As the banks are slowing putting liquidity back into the market, many people are also considering applying for new credit or extending credit regardless of whether they are purchasing a home or not. Thus, a lot of people may be turning their minds to their credit score and how to improve it.
A credit score (or a FICO score) is a number between 0-800. The higher the number, the lower your risk to lenders and, ergo, the better your credit terms. Conventionally, any score over 750 will typically allow you to obtain the best credit terms. FICO estimates that 40% of the population has a credit score of 750 or greater (here is FICO’s primer on how credit scores work).
If you need to raise your credit score, the tired and true is to pay on time all of your accounts with your oldest accounts being kept in the best shape. But, if you are looking for some alternatives to raise your credit score, consider theses:
PREAUTHORIZE ONE PURCHASE ON AN OLD CREDIT CARD. Most of us have very old credit cards that we may not use because the rewards program is not great, the credit too small etc. Instead of canceling the old credit card-which impacts negatively on your credit score- pre-authorize one small transaction on it a month (newspaper subscription, membership fees, phone bill) and pay the entire amount off immediately. Do not run any other transactions on that card.
Why does this work? Several reasons: (i) you maintain positive payment history (payment history determines 35% of your creidt score); (ii) you keep your credit utilization low (balance owing is 30% of your credit score) and (iii) maintain activity on an aged account (15% of your credit score).
MAINTAIN A LINE OF CREDIT BACKED BY CASH COLLATERAL. This one was told to me by a banker and especially useful if you have emerged from bankruptcy or have bad credit history. The key is you have to earn someone’s trust. Open up a line of credit (”LOC”) which is backed dollar for dollar in cash collateral held in a GIC or money market fund at the same bank you obtained the LOC; this will help someone with bad credit obtain a LOC since the bank has de facto secured interest for an unsecured credit line it usually only gives to people with good credit scores.
The money for the collateral is put up by someone you trust (the “guarantor”). Arrange for the line of credit to be withdrawal only if both the borrower and the guarantor sign for it (your bank can arrange this). Then, you make a deal with the guarantor: every quarter you draw down on the LOC in a very minimal amount only IF you have the cash to pay it back immediately (perhaps you give the cash to the guarantor first).
Why does this work? You are taking the following positive steps: (i) establishing payment history; (ii) establishing a a type of credit in use properly (10% of your credit score); (iii) maintaining low credit utilization.
Thus, rather than do a straight guarantor arrangement (which can work), you have put in mechanics (duel signing authority) to control the use of the LOC which should give your guarantor a measure of security (assuming your guarantor has the discipline to say no to you). It is actually a practical manner to build a credit score of someone who has been undisciplined in their spending in the past.
BUILD BACK UP GOOD HISTORY ON A BAD AGED ACCOUNT. Many borrowers, after they have had a bad history with a credit account, stop using it and open up a new account. This is generally a bad idea. A new lender will look up your credit score (which decreases your score) and the credit score system favors aged accounts over new ones. The better thing to do is to begin to make regular payments on all your old accounts.
Why does this work? Re-establishing payment history and reducing amounts owing are the two largest factors in determining a credit score. Open new accounts quickly and having multiple inquiries into your credit score account for 10% of your credit score but it is often used negatively.
Its easy to destroy your credit score. Harder to maintain it. The key is to be regular in payment and be disciplined in how you use your credit. Good luck.
Anyone else want to share any alternate tips?
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