What Makes Up Your Credit Report?

Everybody wants good credit. How do you get it?  But what makes up good credit?

Three organizations collect credit information, Equifax, Experian and Trans-Union. In turn, these companies factor the credit into a single credit “score”, called a  FICO, Fair Issac rating, and sell this information to lenders, credit card companies,banks, basically any credit-granting organization. Each company collects slightly  difference information and computes the score slightly differently, so your FICO is different for each credit-reporting agency. Mortgage lenders usually collect all three and use your “middle” score as your rating. Anything in the 400s or 500s is bad credit, in the 600s is OK and in the 700s, especially above 750  is very good to excellent.  In the 800s is golden. 850 is the max.

So, what makes up your credit report? Of course, the most important component in your credit report is your payment history. This represent about 35% of your final “score”. Typically, your landlord does not report your payment history to credit reporting agencies so good payments there will not build your credit. Some utility companies do report; some do not. To find out, ask. What will build your credit? Well, buy a car and pay for it in installments, making every payment on time. Or, get a Macy’s or Kohl’s card or a gas card and make your payments every month on time.

The next component is the amount owed. This represents about 30% of your credit score. Paradoxically, the more debt you have, the better your credit score--to a point. Each credit card, for instance, has a credit limit associated with it, perhaps $10,000 or $15,000 or $30,000 or $50,000. Let’s say you have three cards with $10,000 credit limit each. You now have $30,000 in potential credit. You can borrow  up to $15,000 and increase your credit score, as long as you allocate it correctly. Never use more than 50% of your credit limit. So, in this case, you could borrow $5,000 from each card.  As you accumulate cards and debt, as long as you pay at least the minimum every month, though, obviously more is better, your score will continue to rise. Further, your credit card companies will continue to raise your credit limits. Eventually, that $1000 limit you started with may rise to $50,000.

The next component of your score is the length of your credit history. That’s worth about 15%. Youth is not an advantage here. The longer you have had credit and managed it well, the better for you. If you have had a bankruptcy or a foreclosure or lates on credit cards, it takes time to “get over” these events before your score begins to rise again. As long as you handle what credit you have correctly, your score will rise.

Getting new credit accounts for about 10%. Be careful here. Try not to collect too many cards or too many loans. If you can keep track of all of them, fine, but it’s easy to miss payments if you have 20 active cards and loans, so take it slow.

The last component making up about 10% of your credit score is types of credit. Vary your credit among revolving accounts, such as department store cards; credit cards; auto loans and mortgages.Gas cards are an easy type of credit to get and manage. Mortgages are more difficult to get and more difficult to manage well. Most lenders put a limit on the number of mortgages you can have.

Once you’ve established credit, there are many ways to improve it quickly and, as we all realize to our chagrin, it is very easy to drop your score by a huge amount for a relatively minor infraction. If you would like to know what our credit score is right now, several sites give it to you for free. Check out Annual Credit Report, Credit Karma or Quizzle.

Short Sale v Short Payoff…What’s the Difference?

In an earlier post, Short Sale v Foreclosure, we saw the difference between a short sale and a foreclosure, but there is another option for a distressed  homeowner. This is the Short Payoff. This option makes sense only under special circumstances.

What’s the difference between Short Sale v Short Payoff?

In our current real estate environment, short sales are becoming more common. A short sale occurs when  the lender or investor agrees to accept an amount less than actually owed on the property. The lender sells the property “short.” In this case, it’s up to the homeowner, usually using a real estate agent, to market and sell the property. The new buyer usually gets a bargain. The previous homeowner gets out from under an unmanageable mortgage by giving up the house.

In order to qualify for a short sale, generally speaking, the homeowner must demonstrate a verifiable long-term hardship rendering him unable to pay the mortgage. These days,  many homeowners, especially those who bought within the last several years or those who refinanced and took big chunks of equity out of their properties, becoming “upside down” in their home loans or owing more than the home is worth. Now, more and more often, these homeowners are also doing short sales.

So far, this doesn’t sound like such a bad deal. The house I bought loses value, so I sell it at current market rates and the lender takes the loss. Well, true, but the homeowner no longer has a home. And, the former homeowner will probably be a renter for several years to come as his credit report’s FICO score will immediately drop by about 300 points. The newest loan guidelines from Fannie Mae and Freddie Mac specify that after a short sale, a prospective borrower must wait for 2 years to qualify for any  FHA- or government-backed loan.

So, what’s the alternative that will NOT damage credit to such a degree?

That option is called a Short Payoff. It also carries some tough restrictions. If the homeowner is upside down by a smallish amount, say $10,000 to $50,000, depending on his  financial perspective, he might try to negotiate a short payoff with his lender.  In this scenario, the lender agrees to release the lien, his interest in the property, allowing it to be  “conveyed” or sold to a new owner.  The lender agrees to accept less than the amount owed on the property to release the lien, thus “short payoff,”   However,  in return, the former homeowner signs a promissory note for the difference or some of the difference agreeing to “pay off ” this unsecured line of credit according to the terms of the note.

To do a Short Payoff, the mortgage must be  current, the borrower must have  great credit, and must demonstrate the ability to pay off the debt.  The upside of this situation? The former homeowner keeps his great credit and can purchase another home or anything else he desires.

When is a  Short Payoff appropriate? A homeowner might  request a short payoff when the home has lost value dramatically or even just enough to make it impossible to sell, and he does  not have the ability to pay the large amount to get completely out of the property.

Not all lenders will allow for a Short Payoff; however,  you will never know if you never ask.
Of course, the advantages of short Pay-offs are the borrower are able to move out of the property and get on with his life, there SHOULD receive no negative feedback on the former homeowner’s  credit.

If for some  reason down the line, the borrower’s  ability to pay changes and cannot pay on the note, the credit ramifications are significantly smaller.

For further clarification of the entire short sale, foreclosure and short payoff differences, I have just posted an E-Book, Should I Short Sale My Home or How To Survive the Worst Real Estate Market in History, available as a free download, on my website. Plus, it appears in Links to the right of this post.