Tanking Credit Scores For Perfect Credit Card Payers. The New Trend Is Here To Stay.
For many of us, maintaining a good credit score is a top priority in life. We may overlook getting that oil change or forget the annual physical at the doctor's office, but we do everything necessary to pay our credit card bills on time, believing that on-time payments will maintain a high credit score.
In the past, this may have been true. Today-it is not the case, perfect payments don't mean perfect credit scores. Here's why.
FICO Score Calculations: Yesterday And Today
Your credit score, or FICO score, is essentially a calculation used by lenders to determine your eligibility for a loan, how much you can borrow and the corresponding interest rate.
Previously, your credit score was a mysterious, hidden computation that was primarily based on your payment history. Today, the breakdown of your score is a more clear-cut computation based on numerous important factors.
The five different factors used to calculate a score range of 300-850 need to be carefully examined and understood:
- Payment history. This portion focuses on whether or not payments were made on time. It accounts for 35 percent of the score.
- Amounts owed. This portion examines outstanding credit accounts and how much is owed on each obligation. This makes up 30 percent of the score. It's called utilization and it's now essential to maintaining a high credit score.
- Length of credit history. This portion reviews how long the applicant has used credit. Generally, a longer credit history leads to a higher FICO score. This makes up 15 percent of the score.
- Credit mix. This portion looks at the different types of credit given (e.g. retail store accounts, auto loans, mortgage loans). This makes up 10 percent of the score.
- New credit. This portion reviews how many accounts were recently opened, triggering a potential credit risk if a borrower opens "too many" lines of credit. This makes up 10 percent of the score.
All of these are important, but number 2 above-also referred to as credit utilization-is the newest and most important factor in your credit score and your daily life. Here's why.
Perfect Payers Don't Have Perfect Scores
In the past, if you had a steady income and always paid your bills on time, you were rewarded with a higher credit score-even if you had an unhealthy debt burden.
Not so today. Outstanding debt is now a huge part in a FICO calculation-and that is why many of today's so-called "perfect payers" are ending up with diminishing FICO scores. These utilization rates are the central component to rewarding perfect payers with perfect scores.
So what's the answer to those of us who ask: How do I really enhance my credit score today if simply paying on time isn't the best approach?
Reducing Debt Load
The best means to enhancing your credit score is reducing utilization and a healthy debt-to-income ratio. High utilization indicates a poor debt-to-income ratio and no amount of perfectly timed payments will overcome this element to avoid a tanking credit score or an overwhelming burden on your day-to-day financial life.
Why There's No Better Savior Than Debt Reduction
While it's important for you to pay your bills on time (since our FICO score is determined in part by our payment history) focusing solely on making payments on time as an exclusive strategy to boost your score isn't wise.
Debt reduction is the answer. An unhealthy debt-to-income ratio is essential to a solid credit score and financial health. Too much debt makes it impossible to obtain good lending rates or a balanced monthly budget.
However, simply making payments on a $30k credit card balance is a bit easier said than done. In many cases, credit cards come with high interest rates, making it virtually impossible in some instances to pay off the principal in an acceptable amount of time.
Many of us may think about reaching into our 401k savings to pay off the debt. After all, it would give us an immediate clean slate, right?
This is a drastic and often improper alternative made by individuals and families in trouble. There are often better options and none should be overlooked or disregarded without experienced legal advice on better avenues for debt relief.
Why You Should Consider All Avenues For Debt Reduction And High Credit Scores
There are various proven legal options for debt reduction, including debt settlement and debt relief. And, an experienced debt relief attorney will know the best option under your specific circumstances, including Chapter 7 and Chapter 13 bankruptcy.
In our society, bankruptcy is often regarded as a last resort, a decision that will crush your creditworthiness in perpetuity. But this simply isn't true.
Paradoxically, your FICO scores may in fact go up post-bankruptcy because of the reduction in your utilization. Credit card offers and car loans are actually available within weeks or months of a bankruptcy discharge and getting approved for a mortgage no longer takes years.
Bankruptcy is an important legal decision that is used by many people, but only with the benefit of experienced legal counsel. In certain circumstances, it is the appropriate method to a lasting financial future within increased credit scores and a healthy reduction in your overall household debt burden-all while preserving your savings and retirement portfolios that took decades of work to build and grow.
In today's economy, everyone needs to take the time to become educated about their particular financial circumstances with the help of an experienced legal professional.
To learn the best options for you and your family, meet with a specialized debt relief attorney.
The Law Offices of Neil Crane, LLC, is a debt relief agency with 30+ years of experience helping individuals, families, and businesses find lasting solutions to their credit card debt and other loan obligations.