One of the biggest problems dealing with FICO scores -- those all-important numbers that play such a major role in both your ability to get a mortgage and in the interest rate you'll pay for it -- is that some of what goes into them doesn't really seem to make sense. The key word is seem. Why, for example, would canceling a credit card lower your FICO score? Why should having someone just look at your credit history hurt you? And just what is a de-duplication window?
There are some aspects of FICO that to consumers seem counterintuitive, or oxymoronic, says Craig Watts, public affairs manager for the Fair Isaac Corp., in San Rafael, Calif., which created the FICO scoring system. But, he says, They do make sense once you understand how analytical modeling works.
Your FICO score is a complex blend of information gathered from five different areas. Your credit history is the most important element, and it is worth 35 percent of your final score. How much you owe compared to your actual credit limit is worth 30 percent. The length of time that you have had credit is worth 15 percent, and the types of credit you have and how often you apply for new credit are worth 10 percent each.
With that in mind, canceling a credit card would seem to be a good way to increase your score. Watts says that some real estate agents and mortgage brokers who don't really understand how FICO works actually advise clients to do so. The problem, he says, is that it changes your credit utilization rating for the worst. You are removing available credit from the table without paying down your total debt, so it appears on paper that you are closer to being maxed out from your open accounts.
Let's say you have five credit cards and a $10,000 limit on each of them, giving you $50,000 in available credit. Now let's say you owe $25,000 on them. That means you are using 50 percent of your available credit. If you had one credit card that you owed nothing on, you could cancel it. Doing so, however, would reduce your credit limit to $40,000, and you would then be using 62.5 percent of your available credit. That puts you closer to the edge, Watts says. You now have less available credit -- less room to move.
This, however, does not mean that you should rush out and apply for new credit cards in order to get a mortgage. To get a new credit card, people would look at your credit score and, even though they might not do anything except look, that can hurt you. It depends on who is doing the looking and why.
The three major credit-reporting agencies -- Equifax, Experian and TransUnion -- keep track of every credit inquiry. But not all those looks are counted when your score is calculated. So, it's a matter of figuring out which ones count and how they count, because some inquiries do damage your score.
There are soft inquiries and hard inquiries, Watts says. When a company checks your credit history before sending you a you have been preapproved letter offering you a new credit card, it's a soft inquiry. Your bank will periodically check your credit history in order to help you manage your accounts. They also look for people with credit difficulties, he says. This is also a soft inquiry, and soft inquiries do not count against you.
FICO only pays attention to those inquiries resulting from the consumer's active pursuit of new credit. Those are the hard inquiries, explains Watts. Consider, for example, people who are new to managing credit. They've had credit cards for a year. If they were to apply for 10 new credit cards all at the same time, those inquiries will lower the score.
That's because the consumer is behaving in a way that statistically is much riskier than others with a similar credit record, Watts says. When you look at millions of records, that behavior is similar to that of those who will have serious problems over the next two years. Another example would be someone with several recent delinquencies. If that person were to apply for five new credit cards within week, that's an obvious alarm bell. The risk of nonpayment has suddenly gotten worse.
Watts says, The typical impact of a single hard inquiry on your score is less than 5 points. But if you have a bunch, the impact is greater. However, when you are looking for a mortgage, you need to talk to a number of lenders -- at least three -- to see who will offer you the best deal.
That's where the de-duplication window comes in. FICO used to look at your history for the last 12 months, and when it saw two or more hard inquiries for the same type of mortgage or auto loan within a two-week period, it ignored all but one of them. FICO assumed you were checking with a number of different lenders in order to make sure you get the best deal. No matter how many lenders you check with, you will probably take out only one loan. FICO doesn't treat credit card inquiries like that, because people don't shop for credit cards the way they do for mortgages and auto loans.
FICO expanded the two-week window of opportunity to 45 days because we observed that consumers are spending a lot more time shopping for the best auto and mortgage loans than they used to. We assume it's because the variety of these loans is so much richer than it used to be, says Watts. If FICO had not expanded the window to 45 days, we would be duplicating the hard inquiries for the same mortgage. Our analysts, being analysts, call this the de-duplication window.
De-duplication windows. Getting rid of credit actually hurting your credit. Inquiries into your credit hurting your FICO score. At first glance, they may not seem to make sense, but when you understand them, they just may help you get a better rate on your next mortgage.
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