Sunday, March 3, 2013

How Bad Credit Affects Your Credit Score (Part 3/3)

Part 3:  The effect bad credit habits have on your credit score

In the first 2 parts we talked about 2 of the most popular credit scoring models. Now I'm going to try to expose how the different bad categories affect your credit.  When I say "categories" I'm talking about collections, charge-offs, liens, late pays, judgments, bankruptcies, and accounts that are showing "Settled".  All of these things are negatives and hurt your credit score.  What's worse, is that they cost you money in higher interest rates, higher insurance rates.  Even your ability to get a better paying job, (or a job at all, in this economy), can be affected.

When you have negative credit on your credit report, the negatives cost you the most points when they are newly reported.  As time goes on, your score will raise a bit, regardless if you paid off the negative tradelines or not.  I always tell people that a negative is bad and once bad, always bad - even if its paid. It is just a "Paid" bad and costs you points.  In fact, when you pay an old negative, it sets a new date for how long that negative can stay on your credit.  That's one of the reasons why I don't advocate paying old debt at all.  You need to get those off, not just showing paid.

Exactly how the scoring and how many points for each baddie is figured, I can't say.  I do know some general information.  They like to keep the percentages and algorithms a secret.  Its my opinion that they do this because they don't want everyone having good credit.  Bad credit is Big Money.  Think about it, when you are offered pre-approved cards in the mail, they are almost always attached to higher interest rates, annual and sometimes monthly fees, teaser rates to start off with and then the rate jumps, and almost always, the type of cards offered are for people needing to rebuild their credit.  

These companies get your information from the bureaus.  The bureaus sell your information. They have lists of people grouped and categorized for sale. Those with bankruptcies approaching 2 years, those with paid collections or charge-offs, low FICO score range lists.  This is one of the main ways bureaus make money.  Now, these companies offering the credit cards, the ones that buy the lists from the bureaus, they stand to make a ton of money because the interest rates and fees are higher than what someone with A credit will accept.  As I said before, bad credit is big money, its big business.

So how many points do these negative items cost you?  Its not the same amount for every person. One thing that affects the amount your score will drop is what the FICO score was before the negative was placed on the credit.  The higher the credit score, then the more points a negative mark will cost you. I believe because this is true, that the points it costs you is a percentage of the starting score.  Also, the amount of points you get back when you get the negative removed is generally going to be less than the amount it cost you because the longer the negative is on your report, the less it costs you.  In other words, every time your credit score is updated, you may gain a few points.  Sometimes it updates because a new negative is put on, but it can be offset by the score raising a little bit, from the length of time older baddies have been on the report.  So time and changes to the report affect the score.

Here are what some of the different "baddies" will cost you in points, and why you need to get these deleted from your report, not just paid off.  Remember, its based on what your starting score it.

New Collection:                   Avg. 50 - 150 point drop for each one
Points lost are based on your starting score and the dollar amount of the collection reported.  It is a confusing formula, but this is what I have learned through research.  Initial points lost 50-100 for the first $236 then another 35-50 points lost for each additional $354. Then, they add back some points ranging from 76-175.  On a $1200 collection with a starting score of 700, there would be a loss of approximately 112 points.
Charge Off:                          Avg. 50 - 150 point drop for each one
Points are lost based on your starting score, but don't forget, this point drop is in addition to all the drops your score has suffered from the points lost for each 30 day late pay (and 60 - 180+ late pays), and then, when they sell it to a collection agency, you get dinged again when they report!
Late Pays:                            Avg. 60 - 110 point drop for each one
Points are lost based on your starting score.  The higher your score was to start with, the more points it costs you. With each successive late payment, it should drop less and less because the score is lowering each time.  But, late pays really hit you hard and cost you a lot of points.
Bankruptcy:                        Avg. 130 - 240 point drop
Points are lost based on your starting score.  You see the effect right away, but it causes all the collections, judgments, anything included in the BK to show paid. By the end of 2 years, your credit score can really see some recovery.  I've seen some credit reports that had the whole payment history removed on accounts that were included in the BK.  Removing all those late pays, helps offset the huge point loss you get from BK's.
Foreclosure:                        Avg. 85 - 160 point drop for each one
Points are lost based on your starting score. Don't forget, you have been losing a ton of points all along with the late pays and NOD's (I don't know what an NOD point cost is - I figure probably similar to another late payment).
Judgment:                           Avg. 50 - 150 point drop for each one
Points are lost based on your starting score. Again, you've most likely lost points already for late pays and charge off, and collection. This is just another hit with a hammer. Time passing does help. Paying it helps because it really affects your debt ratio, and if you try to buy or sell a house, it will have to be paid before escrow can close.
Settled Account:                 Avg. 45 - 125 point drop for each one
Points are lost based on your starting score. You've probably been hit with late pays, charge off, and / or collections, costing you a ton of points before you get to this scenario, then you get to lose more!  But, I absolutely loathe settling accounts. First, I don't agree that you actually owe most creditors, and definitely not a collector.  But what's worse, is you will get a 1099 Tax Form making you pay taxes on the amount forgiven as if it was income!!!!  Can you hear me screaming not to do this?
Maxed Out Account:             Avg. 10 - 45 point drop for each one
Points are lost based on your starting score. I think the higher monthly payments you have to make on the account are worse than the point drop you get.  Besides, as you keep making payments, you'll recover from this one fairly quickly - at least if you can make more than just the minimum payments.
"Hard" Inquiries:                   Avg. 5 - 55 point drop for each one
Points are lost based on how many you have in a short amount of time. If you're applying for credit all over the place, that's going to cause a lot of "hard" inquiries - the kind that cost points and everyone that pulls your credit can see. If you're applying for a mortgage, they don't count multiple pulls against you though, if they are within a 30 day period, because they know that loan officers may be required to pull several times when "shopping" your loan to get you the best rates.  Also, points from inquiries only affect your score for 1 year, and then there is no impact from them at all.

When you remove negatives like these from your credit report, you can expect to see your score increase.  I don't know the formula for that either, but you can sort of figure it will be about half the points from the low end to half the points of the high end in the point range for each item.  This is because time heals a bit and the points you initially lost are greatest right away then slowly you start getting some back.

Well, I hope I was able to give some information that may answer some questions. Please remember that because the algorithm is not disclosed, these numbers are just from testing and tracking done by research groups trying to have a better understanding of the scoring formula, and bits of information that FICO releases to give a little insight into how they score in order to help people manage their credit.                      

No comments:

Post a Comment

I have disabled CLICKABLE LINKS in comments to prevent spam.

Don't to forget to subscribe by email to get updates and replies to your comments!