5 Big Credit Mistakes

It's surprising how many consumers make the same credit scoring mistakes over and over again. In an effort to educate consumers on credit and credit scoring, we've compiled 5 common credit scoring mistakes into a list that defines each mistake and explains why they are bad and how to avoid them:

Credit Mistake #1: Closing Credit Cards Accounts

This is probably THE biggest credit mistake that consumers make. What you may find surprising is that closing credit card accounts can hurt your credit score almost as badly as missing a payment.

Not only is this the number one on the top five credit scoring mistakes, it's also number one on the list of credit myths.

Ironically, most consumers make this mistake based on poor advice from a mortgage lender as a strategy for improving their credit scores. A word of advice people, when you're dealing with something as sensitive as your credit and credit scores, make sure you do your homework before trusting some of these so called 'industry experts' before following through with their advice.

There are two important reasons why you should not close credit card accounts:

1. Eventually, the accounts will fall off of your credit reports - The information in your credit reports are subject to certain rules in regards to how long it can remain in the report. In most cases, credit information will remain in your credit reports for seven years from the account's DLA or date of last activity.

When an account is open, the DLA will continue to update each month and the open account will never reach that seven-year mark.

If you close the account, the DLA will stop updating and the clock will start ticking. Eventually the account will be completely removed from your credit reports.

Why would this be a bad thing?

It's simple - you never want to get rid of old, positive information in your credit reports. This information actually helps your credit scores.

Credit scores want to see this positive account information. They want to see your long, perfect history of making your payments on time because this information significantly helps your credit scores.

This information significantly helps your credit scores so why would you ever want that history to disappear? You wouldn't! Here's an analogy for you: let's say you made straight A's in high school. What if the record of that perfect scholastic accomplishment were permanently deleted seven years after you graduated? Would you ever want that history deleted? Of course you wouldn't. The same is true for the credit reporting environment.

So, what should you do with old credit cards that you don't use any longer?

What you don't want to do is to let the account become inactive. When this happens, the credit card companies aren't generating any revenue for your account.

Eventually they'll close the unused account because you're more of a liability than an asset. You can prevent this from happening by using the card every few months for low dollar purchases like dinner or a tank of gas.

When the bill comes in, just pay it in full. If you do this, it will ensure that the account will never be closed and you'll always get credit for your good payment history.

2. You could cause a spike in your revolving utilization and tank your scores - The percentage of your available credit in comparison to the debt you owe is a very important factor in calculating your credit scores.

This is often called "revolving utilization," or your debt-to-limit ratio.

For example, if you have an open credit card with a $1,000 credit limit and a $500 balance then you are using 50% of your available credit. This means that you are 50% utilized on this particular credit card.

Now lets add a second credit card to the mix.

Let's say you have another open, but unused credit card account with a $1,000 limit and a $0 balance. This would put your total revolving utilization at 25% because you have $2,000 in available credit limits and $500 in total balances.

If you divide your total balances by your total credit limits, you'll get your total aggregate revolving utilization: $500 divided by $2000 equals .25 or 25%.

So how will closing unused credit cards hurt your credit score? When you close an account, the amount of available credit decreases, which could result in a higher revolving utilization and lower your score.

Let's use the example from above and close the second unused credit card account. When you close the account, you remove it from any utilization calculation and now you're stuck with one open credit card account with a $1,000 limit and a $500 balance.

This caused your utilization to go from 25% to 50%.

Remember, you divide the total balance by the total available limit so $500 divided by $1,000 is .50 or 50%. As this percentage increases, your credit score decreases.

When you're talking about several unused credit cards with high limits, you can just imagine what closing credit card accounts could do. I've seen consumers go from a 10% utilization to almost 100% utilization because they closed all of their credit card accounts except the one they were currently using.

Big mistake.

Credit Mistake #2: Missing Payments

It doesn't take a credit scoring expert to tell you that missing payments is a bad thing. The only reason I made missing payments second to Closing Credit Card Accounts is because this one is a no brainer.

It shouldn't take a credit expert to tell you that missing payments is bad. Common sense should tell you that missing payments is bad. Credit scores are designed to predict how likely you are to miss payments in the future.

This means that they look at your credit history to view how you've managed all of your credit obligations.

Missed payments is the most powerful predictor of future late payments. The FICO score evaluates previous late payments in three different layers:

How Severe - How severe is the late payment? It doesn't take a statistician to tell you that a 30-day late isn't as bad as a 90-day late. The more severe the late payment, the more damaging it is going to be to your credit scores.

Consumers who have missed payments by a few weeks and then bring their accounts current score much better than consumers that have gone 90+ days past due. In fact, a 90-day past due is the threshold that will wreak havoc on your scores.

If you are unable to avoid a late payment, the next best option is to get those accounts current as quickly as you can.

How Recent - How long ago did the late payment occur?

If you've read some of my previous articles on credit scoring, you'll know that the last 24 months of your credit history are critical because the FICO score places more emphasis on your recent credit patterns.

This means that a late payment 6 months ago is going to carry much more weight than a late payment from 4 years ago. To recover from late payments it's important that you get current and stay current.

How Frequent - How often have the late payments occurred? Consumers that miss payments frequently are penalized much more severely than those that have missed a payment here or there in their past.

If you have a tendency to make late payments your credit scores will reflect your bad habits. Make your payments on time and you'll never have to worry about losing points in this category.

Credit Mistake #3: Settling Accounts

One of the most common mistakes consumers make is assuming that 'settling' with a lender is a great way to save a little cash.

Unfortunately, they don't realize what that a 'settled' indicator in their credit reports is actually derogatory.

"Settling" is a term used in the consumer credit industry that means accepting less than the amount you owe on an account. For example, if you owe a credit card company $5,000 but you can't pay them the full amount then they will likely make you a deal for less than that full amount. They have "settled" for less than the full amount, which is likely much less than you contractually owe them.

This may seem like a good idea because you save quite a bit of money but as far as the credit scoring models are concerned, this is just as negative as other severe late payments.

The only way to avoid the damage to your credit scores is to arrange a deal with the lender to report the account as 'paid in full' as opposed to 'settled'. If they don't agree then it's in your best interest to figure out how to pay them in full or else be prepared to suffer the damage to your credit for the next 7 years.

It's also important to understand that if the account has already made it to the collection phase, the damage is already severe and settling won't really make a difference. Settling is only an option if the account has already made it to a severe delinquency state.Â

Credit Mistake #4: High Revolving Utilization on Your Credit Cards

Most consumers believe that making your payments on time is all it takes to have good credit and earn great credit scores.

What they don't realize is that almost a third of your score is determined by how much you owe on your credit card accounts. If you have high balances on your credit card accounts, you're credit scores could be severely impacted by your revolving utilization.

In order to score the most possible points in this category, I advise keeping your revolving utilization at 10% or less.

Don't be fooled when you hear some of these celebrity experts telling you that 50%, 30% or even 25% is best.

While 30% is considerably better than 50%, 10% or less is ideal. The lower the utilization percentage, the better your score will be. (*To read more about revolving utilization and how it's calculated, please read the revolving utilization bullet in Mistake #1.)

Credit Mistake #5: Excessively Applying for Credit

Whenever you apply for credit your application gives the lender permission to access your credit reports. When they pull your credit reports, it automatically posts an inquiry in your credit record. This inquiry is a record of who pulled your credit report and the date it occurred.Â

Credit scoring models use inquires to determine if and when you shop for credit. Statistics show that consumers who have more inquiries are higher credit risks than those with fewer inquiries.

It is for this reason that the more inquiries you have, the more points you lose in the credit score calculation.

The exact point value of inquiries is a much argued topic and is impossible to give an exact point value because it really depends on all of the other information included in your individual credit file.

The best strategy would be to only apply for credit when you absolutely need to.

This means that you should avoid those in store offers of "10% off" in exchange for applying for a store credit card. This may sound like a great idea but the reality is that while you may save a few bucks on your purchase, those inquiries could end up costing you a lower credit score which could result in higher interest rates on auto or mortgage loans in the future.

There you have it. Now that you know the top 5 credit mistakes, you can avoid making the same mistakes that so many other consumers make.

By: Edward Jamison, Esq.

Collections 101

With the recent mortgage debacle and the subsequent tightening of available credit - it's no wonder that more and more lenders, hospitals, and landlords are turning their focus to collections in an effort to recoup some of their losses.

In the past twelve months I've seen a drastic spike in consumer complaints about collection agencies and their strong-arm tactics. Unfortunately, with the current economic downswing and the constant murmurs of a recession looming ahead, it's only going to get worse. You need to know how to help your clients avoid collections before they happen - and how to deal with them if they do.

Collections will have a serious negative impact on your client's credit reports and credit scores. They are never good and should be avoided at all costs because they are next to impossible to get removed.

But before we delve into how to handle collections, let's clarify what a collection is and how the system works. A collection is an action taken by a lender (or service provider) in an attempt to collect an unpaid or delinquent debt. Some lenders will use their own internal collection departments while others will outsource debts to a 3rd party collection agency.

Either way, the collector's primary task is to convince debtors to pay up.

Collection agencies work with lenders and service providers in two different ways. The first way is for the agency to buy the bad debt so that they own it outright. In all cases collection agencies purchase these debts for much less than the amount owed - usually pennies on the dollar. Another option is for the lender to consign the account to the collection agency. With this option, the lender agrees to pay the agency a percentage of whatever amount their collectors are able to recover. This percentage can vary, of course, but I've seen as high as 50% in some cases.

Once the collection agency takes over the account, they give financial incentives to their agents by rewarding them with bonuses if they are able to collect most - or all - of the outstanding debt. The more the agent is able to collect, the more money they get to put in their own pockets. Unfortunately, this can lead to some pretty ruthless and unethical collection practices.

Avoiding collections before they happen:

The easiest way to avoid a collection is for your clients to pay their bills - and pay them on time. Sometimes this may mean laying aside their pride and paying a bill that they don't necessarily agree with just to avoid it going into collections.

If they don't agree with a charge or feel that they've been treated unfairly by a provider - utility company, cell phone company, doctor, dentist, etc. - withholding payment isn't a wise option. Eventually the service provider will turn the account over to a collector and when they report it in your client's credit report; it will negatively impact their credit for up to seven years.

I can't tell you how many times I've heard from disgruntled clients that refused to pay a bill 'on principle' and then ended up with a $72 collection on their credit reports. It's just not worth the damage it causes. In the long run it's just better for them if they bite the bullet and pay the bill.

When a collection is unavoidable:

We all know that life can throw your clients a curve ball when they least expect it - a job loss, death in the family, unforeseen illness, etc. In these cases, it may be impossible to avoid a collection. If they already have a collection, here are some very important things you should know about:

1. Fair Debt Collection Practices Act. Know their rights as outlined in the Fair Debt Collection Practices Act. If they have a collection and have been contacted by a collection agency, they only have 30 days to dispute the debt or to request the collector to validate the debt. They also have rights that protect them from harassing and unethical collectors. To read a summary of their rights, go to http://www.ftc.gov/os/statutes/fdcpajump.shtm.

2. Statute of Limitations. A lot of consumers confuse the credit reporting statute of limitations with the statute of limitations to collect a debt. In many cases the statue of limitations to sue for contract debt can be much longer than the debt can legally be reported to the credit bureaus. The debts are certainly still collectable, just not reportable. If they have a collection that is close to being removed because of the statute of limitations - 7 years - and they are able to pay it or settle it, have them do so. Collectors are suing to collect their funds more than ever and as I mentioned earlier, it's only going to get worse.

3. Don't ignore the collection! Recently I heard a very well known and highly respected consumer advocate celebrity advising people to ignore collectors if they don't have the money to pay. This is probably the worst advice to follow when dealing with collections. Communication is vital. Avoiding collections does not make the collection or the bill collectors go away. In fact, the collection agency will most likely end up suing you if you owe them over $1,500, and possibly garnishing their wages or filing suit against them. Ignoring them won't stop the process; it will only make it much worse and more expensive in the long run.

4. Paying "In Full" vs. Settling. I always advise clients to pay a collection, or at the very least to try settling with the collector. Remember, the collection agencies pay pennies on the dollar for these accounts. Your clients should try to negotiate and settle the debt for as little as possible. They can start by suggesting 20% of what they are asking and go up from there. Keep in mind that your clients are dealing with professional collectors. They're going to push for them to pay it all up front rather than a payment plan because they want to get their commission sooner rather than later. Don't let them push your clients into something they can't do - structure a deal that works for your clients, not for them. When they do come to an agreement, get it in writing before they make the payment. But always remember…they are not lenders. They don't have to set your clients up with a payment plan. Their attitude is "hey, you already had your chance to make payments to the creditor and you screwed that up. So why should I trust you?"

5. Pay for removal. Some shady collectors will tell your clients whatever they want to hear if they think it will help them get them to pay the debt. If they offer to remove the collection from your client's credit reports in exchange for payment, they shouldn't believe it unless they get it in writing first.

The credit bureaus have strict policies regarding collections. The only way a collection will be removed is if it is an error or if the statute of limitations for reporting has expired. Think about it this way, if the credit bureaus removed a collection just because it was paid, how accurate would their reporting system be? Did the collection exist? Absolutely! If they were to remove the collection it would dilute the value of their credit reports. This is why the credit bureaus will not honor those pay for removal deals. Don't let your clients fall for it unless they have it in writing to back it up if the collector tries to renege on the deal.

To Summarize:

Your client's best option is to avoid collections all together. However, if a collection is unavoidable, the next best thing is to minimize the damage by having them pay it or settle it as quickly as possible. Be sure to tell your clients to get everything in writing, including a receipt, and make sure that the collection agency updates the account as "paid" in their credit reports.

By: Edward Jamison, Esq.