Balancing Act

In a sense lending institutions are a study in contradictions. Banks are in a constant battle with themselves to balance profits against risks.
Nowhere is this more obvious than when you consider the current lending environment.

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On one hand, banks look at lending as a way to generate profits. Then again, banks are somewhat skeptical of your ability to pay off the loan.

In the post-crisis era borrowers need to have a top credit score to receive favorable loan terms. For most banks this comes down to reviewing your FICO score.

What’s a FICO score, you ask?
FICO stands for Fair Isaac Corporation. Since 1958, FICO has been measuring consumers’ credit score by looking at various categories that rate your credit worthiness on a scale from an F rating of 300 to an A+ rating of 850.

So if you have not already taken a look at what the bank will see, you should pull your credit report and get your FICO score from myfico.com

See the chart below from cardratings.com to understand how your financial decisions will impact your FICO score.

Once you have your credit report and your FICO score, you now need to check your report for errors. Up to 30% of consumers who have pulled their credit report have found errors that impact their credit score according to a Zogby poll. Those errors may be costing you money, so the quicker you can get those corrected the better.

Perhaps the most obvious thing you can do to keep your credit rating in the high 700’s is pay your bills on time. Being timely on your bills accounts for 35% of your credit score. So getting the payment in on time is huge!

Utilization is the second most important thing FICO looks at in determining your borrowing power. Utilization is essentially the amount of debt you currently owe compared to the amount of credit available. The target you want to shoot for is 20% or less.

This can be a tricky thing to stay on top of in light of credit card companies lowering credit limits. If you find you are above the 20% mark, try to pay down the debt. Another longer term option is to apply for additional credit which would effectively lower your utilization ratio. In the near term your score might lower slightly so this option should not be pursued if you are planning on applying for a car loan or a mortgage in the near future.

Other things that you will certainly want to keep in mind is that you are rewarded for having a longer credit history. In this sense there is an incentive for keeping those older credit accounts active even if you are not planning to use them. To this end, you might want to occasionally charge something to the account to keep it active.

While it is important to be a good steward of your credit, it is also important to realize that your FICO score is affected by a number of variables. Clearly you do not want to let the credit tail wag your financial dog. In practice it is never advisable to make a purchase or finance an item that you otherwise might not be inclined to. You will be surprised at what you can accomplish with a little time and a good payment record.