Let’s face it – the credit game is rigged. No doubt about it… the good thing is that if we know the rules of the game, we can play it to win. Unfortunately, nobody is ever really taught the rules to the game. Even in the real estate industry, there is so much misinformation and confusion as to what someone can do to maximize their credit scores, nobody seems to be on the same page. As a real estate professional, it is your duty to have a good working knowledge of how credit and credit scores work so that you can properly advise your clients.
What I want to do is clear up some of the common misconceptions about the credit game in order for you to better serve your clients.
A person has 50+ different credit scores. Sounds crazy, right? Well, it’s true. There are several different scoring models and dozens of algorithms in each model. There are the “Big 3” credit bureaus that everyone is familiar with (Experian, Transunion, and Equifax), plus quite a few other credit bureaus such as Innovis, Factor Trust, DataX, CL Verify Microbilt, and others. These all provide the data that the scoring models used to generate their scores.
The most popular question I get is “which one is my TRUE credit score?” The answer is… none of them. The only one that counts is whatever scoring model and algorithm the lender you are applying with uses. Confusing, huh?
The good news is that in the real estate industry, there is a standard that the majority of lenders use. Usually one of the FICO scoring models is the most common – specifically, Equifax Beacon 5.0, Experian FICO Model V2SM and Transunion FCIO Classic Version 4.
With the overwhelming majority of scoring models, paying off old collections does exactly nothing to improve your actual credit score. This is a tough one for people to understand because it defies all common sense and logic. It would make sense that going back and paying your charge-offs and collections would improve your score – but it does not. Before you go crazy, I am NOT telling to pay your bills or not pay your bills – what I am saying is that it won’t help your score. In fact, it could hurt your score. From the date an account is sent to collections, it will be seven years until it falls off your credit report. That’s the date of last activity… If you go back and make a payment, it can show new activity and refresh the account as far as the bureaus are concerned, resetting the clock on that 7-year window.
The mortgage lender you are using may have their own criteria for approving the loan in addition to the actual score, and that may include paying off some or all of your old collections. If that’s the case, then you have to do what you have to do. My advice in that situation is to negotiate with the collection agency or lender before paying and ask them to remove the account from your report completely upon receipt of the funds. They will fight you on this, but they all have the ability to do it – no matter what they may tell you. You will have to talk to someone in management in order to have a chance at this. The kid in the cubicle will simply be reading off a script and tell you they can’t do it. Escalate it, and you have a reasonable shot at getting it removed.
This is the topic of some debate because obviously, the scoring agencies don’t publish their actual criteria, so there is room for speculation. That being said, much of what I am going to tell you has been thoroughly analyzed and independently documented through case studies.
The credit bureaus like to see you have 3-5 credit cards for maximum scoring. Your usage on those credit cards has a dramatic effect on your credit score. If you go over 29% of your credit limit on any individual credit card, it will start having a negative impact on your score. It gets more pronounced the higher you go. If you are maxed out or over your limit, it is killing your score. In addition to individual card usage, the overall usage on your revolving credit also comes into play. Generally speaking, it is accepted that anything over 10% of total usage can start to drag down your score somewhat. Obviously, if you are barely over that number, the effect will be minimal, but it will become stronger as you accumulate more debt.
Here’s the surprise – if you pay off all your credit cards to a zero balance, it will also have a negative effect on your score. Bizarre, isn’t it? To put this into practical perspective, the credit bureaus want you to be in debt – just not too much debt. They will punish you for not using your credit, but if you overuse it, they will also penalize you. So to really maximize your score for a purchase such as a home, you want to have a small balance on your cards – some can be paid off, and the others should have a small balance, keeping your total utilization under 10%.
So there you have it. A down and dirty primer to playing the credit game to win. There is a lot more to it… if you have a problem client, please feel free to submit their info (with their permission) in the form here, and we would be happy to do a free 15-minute consultation and figure out the best solution for their situation.