Bankruptcy & Foreclosures

I know, I know, we hear it all the time: Pay your bills on time and you will be rewarded with a high credit score, slip up and your score drops. One of the most common questions around here is “how exactly is my score computed?” or better yet “how long does a mistake remain on my report?”

I have some good news and, well, some more good news. Fair Isaac & Company (FICO), the group responsible for the current credit score model, is just about set to release a new formula of computation! Better yet, the new formula plans to further benefit those who pay their bills on time.

Since 2006, FICO has been assembling their new credit rating system and may still take a few months before consumers see changes in their credit score (as the bureaus themselves (Experian and TransUnion) adapt to the new rating formula. Interestingly, the new model began development long before the current recession flared up.

So what’s the point of the model makeover you ask? Surprisingly, the core of the new design was intended to alleviate the exact economic situation we’re currently going through! The idea behind it is to provide a better differential between good risk borrowers and bad risk ones by giving creditors a more accurate prediction of the potential for default. What’s this mean to you? If you happen to be a consumer in fair standing with a pretty solid track record for making your payments, your score could very easily jump by as much as 25 points under the new formula.

Let’s take a look at some of the individual areas the new formula plans to improve:

The system treats a single large slip up (even as much as 90 days) as an “isolated delinquency” to individuals with a 10-year credit history. Routine late payments of less than 90 days will still damage your report but at least now a legitimate mistake won’t haunt you so severely.

Also under the new system, multiple credit inquiries in a short period of time won’t be so damaging to your credit score, as now they will be weighted less heavily in calculating the overall number.

Finally, the new system actually rewards borrowers who demonstrate the ability to stay on top of both revolving debt (credit cards, lines of credit) and installment loans (auto loans, mortgages). Believe it or not even if you show a hodgepodge of loans but a solid history of paying them on time, expect your score to jump up as well.

In my last blog post, we took a look at the first five strategies for improving a person’s credit score as excerpted from Jason Rich’s excellent book Dirty Little Secrets: What the Credit Bureaus Won’t Tell You. In continuing with the strategies here are the next five (6-10).

Strategy 6: Correct Inaccuracies in Your Credit Reports, and Make Sure Old Information Is Removed.

One of the fastest and easiest ways to quickly give your credit score a boost is to carefully review all three of your credit reports and correct any erroneous or outdated information that’s listed. If you spot incorrect information, you can initiate a dispute and potentially have it corrected or removed within 10 to 30 days.

Strategy 7: Avoid Excess Inquiries.

Every time you apply for a credit card or any type of loan, a potential creditor will make an inquiry with one or more of the credit reporting agencies (Experian, Equifax or TransUnion). This inquiry information gets added to your credit report and will typically remain listed for two years. For one year, however, the inquiry will slightly reduce your credit score. If you have multiple inquiries in a short period of time, this can dramatically reduce your credit score.

Keep in mind, when shopping for a mortgage or car loan, it’s permissible to have multiple inquiries for the same purpose within a 30- to 45-day period, without those multiple inquiries hurting your credit score. In this situation, the multiple inquiries will be counted as one single inquiry.

Strategy 8: Avoid Bankruptcy, if Possible.

There are a lot of misconceptions about the pros and cons of filing for bankruptcy if you encounter serious financial problems. In terms of your credit report and credit score, filing for bankruptcy is one of the absolute worst things you can do. If your credit score hasn’t already plummeted as a result of late payments, missed payments, and defaults, when the bankruptcy is listed on your credit report, you will notice a large and immediate drop in your credit score. Furthermore, that bankruptcy will continue to plague your credit report for up to ten years.

Strategy 9: Avoid Consolidating Balances onto One Credit Card.

Unless you can save a fortune in interest charges by consolidating balances onto one credit card, this strategy should be avoided. One reason to avoid this is that maxing out your credit card will detract from your credit score, even if you make on-time payments. Assuming the interest rate calculations make sense, you’re better off distributing your debt over several low-interest credit cards. An alternative is to pay off high-interest credit card balances using another type of debt consolidation loan or by refinancing your mortgage with a cash-out option.

Strategy 10: Negotiate with Your Creditors.

Contrary to popular belief, your creditors aren’t your enemies (at least they don’t have to be). Your creditors are in business. The nature of business dictates that they earn a profit. When you don’t pay your bills, that impacts a creditor’s ability to do business and impacts its bottom line. Many creditors are willing to be understanding of difficult financial situations and short-term financial problems, especially if you openly communicate with them in a timely manner.

In other words, instead of skipping a handful of payments or defaulting on a loan, contact the creditor as soon as a problem arises and negotiate some form of resolution that’s acceptable and within your financial means. Forcing a creditor to turn your debt over to a collection agency will simply cause you bigger problems in the future because many collection agencies are relentless when it comes to recovering money. Furthermore, the negative information that’s placed on your credit report will have a long-term negative impact on your credit score.

Sometimes even the best laid plans go awry and we find ourselves in situations of outstanding debt. As expected, with this come the calls from debt collectors reminding you of your outstanding balance. This can be not only inconvenient but downright embarrassing. What it important to remember is that even if you owe money, you do still have rights when it comes to debt collection. Let’s take a look at how the system works.

A collector may contact you in person, by mail, telephone, email, or fax. However, a debt collector may not disturb you at inconvenient times or places (such as before 8 am or after 9 pm), unless you agree to such arrangements. A debt collector also may not contact you at work once you make them aware that your employer disapproves.

You can stop a debt collector from contacting you by writing a letter to the collection agency requesting them to stop. Once the agency receives your letter, they may not contact you again except to confirm that there will be no further contact or to notify you that the debt collector or creditor intends to take some specific action.

It is important to realize that sending such a letter, under the auspices of the Fair Debt Collection Practices Act, to a collector does not make the debt go away. You could still be sued by the debt collector or your original creditor.

If you have an attorney, the debt collector must contact the attorney, rather than you directly.

A collector may not contact you if, within 30 days after you receive the written notice, you send the collection agency a letter stating you do not owe money. However, a collector can renew collection activities, as permitted under Fair Debt Collection, if you are sent proof of the debt.

Remember that even collection agencies have to follow the letter of the law. Any of the following would be considered harassment:

• Threats of violence or harm.
• Publishing a list of consumers who refuse to pay their debts (except to a credit bureau).
• Using obscene or profane language.
• Repeatedly using the telephone (such as calling back continually)

As always, the most effective way to get rid of the collector is make good on your balance.