June 24, 2019
This is the first of a 5-part series to clear up the confusion about what goes into your credit score.
Having recently published my book Crack The Credit Code, I have done a lot of research on the subject and have found that there are many myths and misunderstandings about credit.
Because of the complexity of credit, there have been many vultures who have taken advantage of the public. Specifically, there are lenders who charge unbelievably high interest rates because the borrower “has no other options”.
Honestly, there are hardly any situations where there are no other options. If someone tries telling you that you can’t go anywhere else to get what they are offering (unless it is a zero interest loan), you should probably go elsewhere. In fact, you should probably run.
To help simplify the subject, I will begin with the part of your credit report that has the most effect on your score. Not surprisingly, it is your payment history. But most people think it should have more effect than it does.
Payment history accounts for 35% of your credit score. This is only a little more than one-third of your score.
Most of us, if we were told anything at all about credit when we were growing up, were told little more than, “Pay your bills on time.” If only it were that simple. Unfortunately, it isn’t.
The good news is that you can understand how it works and what effect it will have on your score.
There are three basic part of your payment history: Recency, Frequency and Severity.
Recency is simply how your recent payment history looks. Were there any recent late payments or not? The most recent activity has the most effect on your score.
Frequency means how many times you have had late payments. If you have one late payment in the last two years, it will not have as much effect as if you had ten late payments. It should be noted that it doesn’t matter how large or small the payment was. It will have the same effect.
You should also know that if you have several late payments on one account, each one counts as a late payment. For example, if you fall behind on your car payments so that you are a month behind but paying every month, your credit will be dinged for a late payment every month.
Severity is just what it sounds like. It refers to how severe or late a payment is. In other words, a payment that is thirty days late does not hurt your score as much as a payment that is ninety days late.
Another important piece of information about late payments is that they only get reported once you are 30 days late. So while you can be late in the eyes of a creditor and you can be charged a late fee, if your account is not 30 days past due, it will not be reported as a late payment to the credit bureaus.
So how do these three factors (recency, frequency and severity) work together? By looking closely, we can use this information to limit the damage if you fall behind or don’t have enough money to pay your bills.
Let’s say a guy has enough to pay most of his bills but either his income dropped or he had some unexpected expenses one month. Now that he knows he can’t pay all of his bills, he has to make some choices on what to pay and what to delay.
If he is short by $200 and he has a car payment of $300 along with three credit cards with payments of $40 each, he could either pay the car payment or the three credit cards. I have had many clients who paid the car payment with the idea that being late on he credit cards is less important because the payments were smaller.
But this would cause them to have three late payments instead of one, causing a much bigger drop in their scores. The correct thing to do would be to pay the credit cards and delay paying the car payment (assuming everything else is on time and there is no threat of having the car repossessed which would not happen with a single late payment).
Another thing that could help in a situation like this would be to talk to the lender on the car loan and see if they could put that payment to the end of the loan without reporting you late. Some lenders will do this for you.
Even though you will want to consider the effect that a late payment has on your credit score, there are some payments that are more important than others. As I alluded to above, you don’t want to put yourself in danger of having your car repossessed.
But the more important thing than your car payment is your mortgage or rent payment. Late payments on these things will not affect your credit score more than other accounts and a late rent payment will not even affect your credit score at all.
What a late payment on your rent can do is prevent you from getting approved when you try to rent your next place to live. It can also cause a mortgage to be denied if you are trying to buy a home. This is especially true if the late payment is within the last twelve months.
The same thing goes for a late mortgage payment. Having a mortgage payment that is 30 days late will do much more than cause your credit score to go down. It will prevent most lenders from giving you a loan at all if the late payment has been within the last year.
This does not mean you can’t get a mortgage if you are late on your rent or mortgage but it will prevent you from getting the best loans available. Depending on the rest of your profile (down payment, credit score, employment history, etc.) it could prevent you from qualifying for the type of loan you need.
What I am telling you here is that while your score is important, it is not the only factor used in deciding what you will qualify for. It is also not the only thing to consider when deciding what bills to pay first.
This should give you a basic understanding of how your payment history affects your credit scores but keep in mind that there is a lot more to know about it and how to use it to gain and keep control over your credit.
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