Question

Melissa Jones has come to you with a problem involving her credit since she knows you are taking a class in Personal Financial Planning and you are determined to help her.

Melissa makes about $40,000 a year and has four credit cards, with a total balance of $8,000. She still owes around $30,000 on a student loan on which she is paying about $375 a month.

Melissa tells you her FICO credit score is 680 and she is paying about 18-20% Interest on her credit cards. A few years ago, she had one of her credit cards stolen and some items were wrongfully charged on it. Melissa wonders if this affects her credit score.

Melissa would like to find out more about her credit score and see if she can reduce her monthly debt payments. What advice would you give her?

Answer 1

Answer-

A credit score is a numerical expression based on a level analysis of a person's credit files, to represent the creditworthiness of an individual. A credit score is primarily based on a credit report information typically sourced from credit bureaus.

Lenders, such as banks and credit card companies, use credit scores to evaluate the potential risk posed by lending money to consumers and to mitigate losses due to bad debt. Lenders use credit scores to determine who qualifies for a loan, at what interest rate, and what credit limits. Lenders also use credit scores to determine which customers are likely to bring in the most revenue. The use of credit or identity scoring prior to authorizing access or granting credit is an implementation of a trusted system.

Credit scoring is not limited to banks. Other organizations, such as mobile phone companies, insurance companies, landlords, and government departments employ the same techniques. Digital finance companies such as online lenders also use alternative data sources to calculate the creditworthiness of borrowers. Credit scoring also has much overlap with data mining, which uses many similar techniques. These techniques combine thousands of factors but are similar or identical.

Melissa can reduce her monthly debt by following ways.

1. Payoff Any Past Due Balances You Owe

This is one of the fastest ways to improve your credit score, at least a little bit. Past due balances weigh heavily on your credit score. By paying them off, you can jumpstart your credit score quickly.

While paying off very small past-due balances may not have much of a positive effect, paying off a larger balance, or several smaller ones, can jump your score by 20 or 30 points.

If you’re applying for a loan, that may be all the improvement that you need in your score.

It’s sometimes possible to negotiate a lower settlement on past-due balances, particularly if the delinquency is pretty old (more than two years).

The creditor may be anxious to settle the account, and be willing to accept substantially less than the original

2. Pay Down Credit Card Balances

If you owe substantially more than 30% of your available revolving credit, paying these lines down is one of the best strategies to improve your credit score.You don’t necessarily have to drop your credit utilization all the way down to 30%. If you’re currently at 70%, dropping it down to 50% can provide a noticeable improvement in your credit score.

3. Payoff Your Smallest Debts

Another aspect of credit utilization that we haven’t discussed yet is the number of accounts with open and active balances.Beyond a certain point, it is possible to have too many accounts with balances on them.However, even a relatively small number of open accounts can be problematic if every one of them has a balance due on it.

One of the best ways to improve your credit score is to eliminate your smallest debts.

Much like maxing out credit cards, maintaining too many accounts with balances is seen as a negative for credit scoring purposes.

4. Paydown an Installment Loan

If you recently opened an installment loan, such as a new auto loan, this will have a negative impact on your credit score.

The reason this is true is because there is a lack of history on the account, so whether or not you can actually manage the new payment is something of an open question.

It’s not quite the same thing as a 12 month payment history, but the reduction in balance will still have a positive effect on credit score.

5. Take out a new credit line but dont use it

This strategy doesn’t actually reduce your debt, but it can have a similar effect, at least as far your credit score is concerned.

If credit utilization is a problem – if your credit utilization ratio is well beyond 30% – one way you can improve this without paying down your credit lines is to take out a new credit line, but not use it.

The new credit line will increase the amount of credit you have available.

For example, if you currently have $20,000 in available credit, and over $14,000 borrowed on those credit lines, your credit utilization is 70%.

But if you add a new credit line for $10,000, your available credit instantly increases to $30,000.

The fact that you still owe only $14,000 means that your credit utilization ratio will immediately drop below 50%. That should increase your credit score.

One caveat here is if you have difficulty keeping yourself from using available credit lines.

Though the new credit line will improve your credit score in the short run, taking draws and making purchases against the new line will ultimately increase your debt, as well as your credit utilization ratio.

At that point you’ll be in a worse situation than you were originally because you will owe even more money.

Use this tactic only if you are sure you have the self-discipline to not use the new credit line.

If your credit situation has already reached the point of being uncomfortable and difficult to manage, get credit help

Credit problems tend to feed on themselves and only get worse with time. Take action while you’re still in control of your situation.