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.                      

How Bad Credit Affects Your Credit Score (Part 1/3)

Part 1:  Breakdown of Your FICO Score

Some of the most common questions I get asked about credit repair are related to how my score is figured and how much will my credit score go up by removing these negatives.  I wish I could just give people an easy answer like, "Collections cost you 10 points each and charge offs cost you 20 points, etc." but its not that simple.  The FICO Score is broken up into 5 categories, but also, people are broken up into categories - or more so, demographics.  It is also based on what your previous FICO Score was before the negatives hit your report. The FICO Score is the model used by almost every lender when applying for major credit.

The five categories of a FICO Score are A) new credit; B) credit mix; C) credit history; D) length of credit history; and E) debt amounts.  I'll try to explain them in an easy way to understand:

• New Credit: This makes up 10% of your score. This is why having inquiries from "hard pulls" affect your credit score.  One or two over several months is not a big deal. But, if you're applying for credit all over town, on the internet, etc. it starts to ding your credit.  New credit is not bad but when you start having lots of inquiries and lots of new credit, all in a short time, your score will go down. The thing that adds back points in this category are utilizing the new credit, paying on time, and time itself.
• Credit Mix: This makes up 10% of your score. It means different types of credit. Revolving credit, installment credit, auto loans, mortgages, charge cards, credit lines, etc. Auto loans and mortgages are installments usually but so are some furniture and appliance store accounts. Student loans are also installment credit.  They like to see that you can handle paying different types of credit on time.
• Credit History: This makes up 35% of your score and represents how you have paid for your different reported accounts. This is where late pays affect your score, and they DO affect your score! It is also where charge offs and collections are factored in. Bankruptcies, judgments, tax liens and other bad credit items all are scored through this category.
• Length of Credit History:  This makes up 15% of your score. This is the category that rewards you for time. If you have credit cards that you've had for several years, it is a plus for your credit. This is the category that reinforces why you should not close "Old accounts" that you are not using. Go spend $5 on something and pay it off. Those oldies offset the affects of bad credit a bit, and when you get "baddies" you really want to hang onto the good ones.  In fact, these old trade lines are what really help your score when you start repairing your bad credit.  Can you imagine if you remove all your bad credit but had closed all your old good credit? You would have NO credit!  So, don't close those old cards, even if they have old lates on them. Lates fall off over time.
• Debt Amounts: This makes up 30% of your FICO Score. This is why finance professionals advise you to keep your debt balance at 30% of your credit limit.  Ideally, you should keep it at 19% of the credit limit because this number is where people have seen the highest credit scoring when they have done tracking and studied it.  Maxing out credit cards and credit lines burns your score pretty badly.  Paying regularly and paying them down so there is a greater ratio between the credit limit and the credit spent (balance) improves your score.

There is also another type of score you see on your credit reports. This is a "VantageScore".  I will explain this one on Part 2.