Le FICO Pt 2

As mentioned here your FICO score and the information that it is made up of can have a huge effect on how much you are actually charged in interest. In my house example, if you have decent credit and can get a lower mortgage rate, the difference in interest payments could mean hundreds of thousands of dollars over the life of your mortgage.

Here’s an example that Suze Orman provides in my favorite book of hers called The Money Book for the Young, Fabulous, and Broke:

Monthly Mortgage Cost on a $200,000 30-year fixed mortgage

Interest Rate	Monthly Payment	Total Paid
4.0	$955	$343,800
5.0	$1,074	$386,640
5.5	$1,136	$408,960
6.0	$1,199	$431,640
6.5	$1,264	$455,050
7.0	$1,330	$478,800

So from an interest rate of 4.0 to 7.0 you could spend an additional $135,000 over the life of your loan, which is all determined by your credit score.

What would you do with an extra $135,000 that you saved from having good credit?

So now that you know you have to keep your credit score in tip-top shape, how exactly should you go about doing that? First and foremost, pay your bills on time. I cannot stress this enough. As previously mentioned it makes up 35% of your score. If you falter there, no matter how good you are at the rest, your score can only be 65% as good as it could’ve been if you paid your bills on time. You don’t even have to pay off credit cards in full, paying the minimum amount counts as paying your bill on time.

But, if you don’t pay down debt and keep your credit utilization high, that’s the next biggest chunk at 30%. So keep your debt low and you’ll have a higher credit score. Pay it down even by 10% and your credit score can improve up to 50 points according to some people who understand the FICO voodoo better than I do.

Now, I once had a friend ask why her credit score was so low since she paid her bills on time and had no credit card debt. It turned out it was because all she had to build her credit score on was one credit card. I hate to say this, but your types of credit make up 10% of your score. This does not mean you should go out and get a new car so you suddenly have a car loan. This means that if your FICO score is low and you if you apply for a loan you need to be prepared to state your case for why you deserve a lower interest rate since you are so responsible with money. But how many of us only have one credit card nowadays?

The third biggest chunk of your score is the length of your credit history. Literally how long you’ve had credit. I had another client who I told to go check on her credit score and since all her utilities were in someone else’s name and she had just opened up her first credit card, she had no credit history and had no score. I told her to check back in 9-12 months and see how she’s doing.

The final chunk (I swear we’re almost through this) is how many credit searches have been done on your credit recently. So if you go apply for a mortgage and shop around at different banks, you’ll get a lot of hits for people looking at your credit. It reads the same as if you opened a bunch of new credit cards. FICO doesn’t like that so your score will go down. But if it’s for a mortgage, after 3 months your score returns to its original level like nothing happened. Which is why it is recommended that you shop for mortgages within a 90-day window.  To avoid lowering your score on this front, just don’t open a bunch of new credit cards at the same time. Easy peasy.

Ok! That’s all of it. I would love some of your questions about FICO myths for Q&A Thursday. Submit them and we’ll see some of the crazy stuff people think about their FICO scores.