Ask Liz Weston

Dear Liz: I have no idea what my credit score is, because as my father said, “You never get rich paying someone else interest.” The only reason to borrow money is for a house or a car or for a home improvement for which a home-equity loan would be best. Credit cards, consumer loans and home-equity loans for non-house expenses are folly.

However, you and many other financial columnists are always advising people on how to keep their credit scores high. The implication is that your readers should be borrowing money when they should not. I use credit cards (for most of my purchases, in fact), but I always pay off my balance, so my credit scores are of no interest to me and I don’t know them.

Answer: You’re laboring under two common misconceptions: that credit scores aren’t important and that you have to have debt to have good scores.

It’s precisely because you don’t get rich by paying others unnecessary interest that you should care about your scores. The reality is that good scores have become critically important if you want the best rates and terms on mortgages, auto loans and other lending.

Credit scores are also used by landlords to evaluate applicants and by insurance companies to determine premiums.

But you don’t need to carry credit card balances to have great scores. In fact, the only smart way to use credit cards is to pay your balances in full each month. You also need to pay attention to your credit limits, since maxing out cards, even if you pay in full, can hurt your scores.

Dear Liz: I began paying down my debt six months ago and have paid off $10,000 so far. I subscribed to a credit score tracking system through a free offer and was told my credit score was in the 670 range most of the time. When I applied for a mortgage loan recently, however, the bank told me my middle score was only 612. One credit bureau said my score was just 590! How is this possible?

Answer: There are many different credit scoring formulas available today, but the one used by most mortgage lenders is the FICO. You have FICO scores from each of the three bureaus, and mortgage lenders typically use the middle of those three scores to determine your rates and terms.

Unfortunately, many of the companies hawking “alternative” scores don’t make it clear to their customers that they’re not seeing a FICO score. The confusion is compounded by the fact that your credit scores, including your FICOs, change all the time, and lenders also use somewhat different versions of the FICO scoring formula, which can produce somewhat different results.

Still, for a score that’s closest to what your lender will see and use, you want FICOs. You can buy your FICO scores for two of the three bureaus at MyFico.com. Unfortunately, Experian no longer sells FICO scores to consumers, although it continues to sell them to lenders. That means you can no longer know in advance what rate you qualify for, since you can’t know what your middle score is until your lender gets all three.

photo credit: Mike Licht, NotionsCapital.com

Credit expert John Ulzheimer reports a disturbing development: a decision by the credit reporting industry to report loan modifications as “partial payment plans.”

From John’s blog:

The issue at hand is how very large mortgage lenders, namely Citigroup, Chase, and Bank of America, may report mortgage loan modifications to the credit reporting agencies and, secondly, how that credit reporting impacts the consumers’ FICO® credit scores. According to the Consumer Data Industry Association, the credit bureaus have agreed to guidelines that loan modifications will be reported as a “Partial Payment Plan.”

The problem with this decision is that FICO credit scores interpret the notation of a “Partial Payment Plan” as negative. Consumers will see their scores decrease some amount of points because of such a classification. How much their scores decrease will depend on from where their scores started.

John notes that modifications typically involve a reduction of interest rates, not balances owed, and are often temporary. Since the lender is not losing any principal, it’s hard to imagine how the “partial payment plan” notation is justified

To read his full blog post, CLICK HERE.

Dear Liz: I have $175,000 in credit card debt. Almost all of this debt was due to balance transfer offers over the years which I managed quite well to make sure I had no balances with high interest rates. Now with credit being so tight, one of my issuers has reduced my credit limits and I can’t find any balance transfer offers to extend my low rates. Will the issuers allow me to settle this debt for less than I owe? I always get offers from credit consolidation companies that tell me banks are willing to accept 50% or less of your balance if you pay the reduced balance amount in full. Can I simply call up the credit card company and offer a reduced amount? If I cash out on my stocks and other investments, I could actually pay the debt off in full so I do have the ability to pay. I just never did so since the interest rates were so low.

Answer: The recession has made credit card issuers more willing to accept debt settlement offers, but your savings will come at your credit scores’ expense.

Card issuers really don’t like it when people don’t pay what they owe. When the notation of a debt settlement hits your credit reports, expect your scores to dive.

Some people have little choice but to accept this price. They can’t pay their debt and, for whatever reason, can’t wipe it out in bankruptcy court. In those cases, debt settlement can be the best of bad options.
You, however, have a choice. Don’t make one you’ll regret.

Dear Liz: My fiance and I are trying to secure financing for our first home, but his credit scores are just below the mark. I was thinking of adding his name to my credit card account so that my available credit line shows up on his report. Would this boost his scores at all? Is there any danger of it lowering his scores?

Answer: If you have a good history with this account — you always pay on time and you’re not carrying a large balance — adding him as an authorized user may help his scores.

The key is whether the credit card issuer will “export” this data from your credit file to his. Some issuers automatically do this export for any authorized user; others do so only for spouses. The only way to know for sure is to ask your credit card company.

If the data is exported to his file, it will be used to calculate his FICO scores, which are the scores most lenders use. The company that creates the FICO briefly toyed with the idea of excluding authorized user data in its latest formula, FICO 08, but ultimately decided to continue using it.

If you add him as an authorized user, you don’t need to give him a card or access to your account. What you should do, however, is take some time to go over his credit reports and discuss what steps he’s taking on his own to clean up his financial act.

A temporary boost in his scores might land you a mortgage, but you could wind up much worse off financially if he continues to mishandle his credit.

Dear Liz: My credit card issuer just told me that I am being issued a new card with a new account number because of a database breach. Will that have an impact on my credit score? Will it change the length of years I have had the credit card?

Answer: The answer to both questions is “probably not.” In these situations, credit card companies typically merge the new account with your old one so that it reflects your long credit history with the previous card.

Once you get the new card, take advantage of your free annual peek at your credit reports via www.annualcreditreport.com to make sure the account is being reported correctly. If not, ask the issuer to combine this account with the one it replaced.

Dear Liz: Experian gave me a 977 on its VantageScore. How does that relate to the FICO score, and how can I get Experian’s FICO score?

Answer: The VantageScore system is on a scale of 501 to 990, which means you rank close to the top. The FICO scoring system ranges from 300 to 850, but there is no way for you to know how your Experian VantageScore relates to your Experian FICO score.

That’s because Experian decided Feb. 14 to stop selling its FICO scores to consumers. Experian still sells FICOs to lenders — just not to you.

This decision has caused a stir among consumer advocates. FICO is the leading credit scoring formula used by lenders, and not being able to see one of your three FICO scores puts you at a distinct disadvantage when you’re shopping for a mortgage or other major loan.

You can still get your FICO scores from the other two bureaus, Equifax and TransUnion, and MyFico.com. That will give you some idea of how you might fare with lenders, few of which use the rival Vantage- Score system.

Dear Liz: In my younger days, I thought it was a smart practice to pay my bills late so I could keep my cash earning interest as long as possible. After having difficulty with a home purchase in the early 1990s because the late payments showed up on my credit report, I changed my perspective and built my credit score to 816 as of October 2008. At that time I had a home mortgage, an auto loan and three credit cards with limits totaling $35,000 and balances that were paid in full monthly.

Recently, I opened a new account to purchase a computer and I paid down my auto loan by $6,000. After these transactions, my credit score dropped 23 points to 793, even though my total debt has dropped and my credit limit has increased. It took 15 years to increase my score by 150 points and just days to drop it by 23 points. Where is the fairness in this system?

Answer: Let’s cut to the chase: If your FICO credit scores are over 760 or so, you really have nothing to worry about, since those scores will help you qualify for the best rates and terms.

But you do have some misconceptions about credit scores and how they work. For example, you don’t have one credit score, you have many, and they change all the time.

The FICO is the leading scoring formula used by most lenders. Each of the three major credit bureaus sells its version of the FICO to lenders. Experian has stopped selling FICO scores to consumers, but you can get your FICO scores for the other two bureaus at www.myfico.com.

Your FICO scores typically won’t drop if you pay down debt. In fact, they usually rise. What probably caused the drop in scores was an increase in the balance on one or more of your credit cards. Even though you pay your cards in full, the balance that’s used in calculating your credit score is typically the balance reported on your last credit card statement. If you ran up a big balance, you hurt your score.

As to your last question, FICO scores weren’t designed to be fair. They were designed to help lenders predict the risk that a borrower would default.