Borrowing from big brother

A peek behind the numbers of financial evaluation setting insurance and loan rates

by Naftali Solomon, President of 718-INSURANCE as reported in the May 2004 edition of the Grand Street News

Three digits in a row, from 300 to 850: How harmful can they be? Plenty.

You probably already know that those numbers, comprising your credit score (often called a FICO score, after the popular model developed by Fair Isaac, the largest provider of consumer credit scoring models) may determine the interest rate on your home loan and credit card, the premium on your auto or home insurance, even your acceptance into a housing cooperative.

But did you also know that if you take out a home-equity loan, the interest rate on your credit card could double? Or that if you miss a student-loan payment, your auto or home insurer may refuse to renew your policy?

Believe it or not, you can qualify for the best rate for a mortgage or home equity line of credit but still be turned down for insurance!

Sounds scary? “Get used to it,” says Chris Larsen, CEO of online lender E-Loan, “Credit scores are the trend of the future.”

It’s a trend that has had privacy-rights advocates up in arms for years. The Senate is debating an amendment to the Fair Credit Reporting Act which would hold lenders to higher standards of accuracy.

With home loans, the FICO score is the “800-pound gorilla,” says Fair Isaac spokesman Craig Watts. For a 30-year fixed $200,000 mortgage in Iowa at the end of September, a score of 675 would have gotten you a 6.4% interest rate, a score of 720 – 5.7%. A difference of $10,320 in loan payments over 10 years.

The biggest factor – 35% – which determines your score is your history of on-time payments. It should come as no surprise, since home-loan FICO scores were developed primarily to predict the likelihood of your defaulting on your mortgage.

Thirty percent of the score is determined by how much credit you use each month. Some card companies will report the highest balance you’ve ever racked up. There’s a timing issue too: Card companies report to credit bureaus on the statement date that appears on your bill, but every month you may have a different balance. Even if you pay the card off in full each month, says Watts, your credit report “will almost always show a balance.”

Home-equity lines of credit affect your credit-utilization ratio, but just how much depends on the amount you withdraw. A sizable withdrawal, more than, say, $18,000 on a $20,000 credit line, is counted as an installment loan. But a small withdrawal of $2,000 on the same line of credit is considered revolving credit and therefore has a bigger impact on your utilization ratio.

The Dos-and-Don’ts of Fixing Your Credit History

It’s a fact: An extra 45 points in your home-loan FICO score can save you almost $40,000 over the life of a 30-year mortgage.

Do keep your credit-card balance under 50% of the credit limit on any card. Do pay off your balance at least a week before the monthly statement date rolls around – it typically falls two to three weeks before the actual payment is due. That’s when most card companies report to the bureaus. Do pay your biggest bills first, if you’re juggling them. The larger the missed payment, the more it hurts your FICO score.

Don’t cancel some credit cards in an effort to help your score. It won’t. In fact, even long-dormant accounts will figure positively toward your history and the extra available credit won’t hurt your score either. Don’t sign up for extra credit cards or request unnecessary rate quotes from lenders. Too many inquiries will drag down your score.

Do build up a track record of paying ordinary bills on time. Insurers like to see a history of responsibility.

Finally: a stream of late payments will hurt your insurance credit score more than it would your FICO. Have any unpaid bills older than five years? Don’t try to clean up your record by paying them if all you’re worried about is your insurance score. Older bills have a minimal impact on it; paying them will only draw attention!