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Myths and factors

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Myths on credit scores and how you are affected.

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Credit Scores - Some Myths and Factors That Affect Your Rating.

One of the myths being spread about credit scores is the notion that paying off old collection and charge-off accounts will improve the borrower's chances of being approved for their home loan application.

For the most part, derogatory credit will remain in a consumer's credit file for seven years -- Chapter 7 bankruptcies last 10 years -- that's seven years from the date last active. When you pay off these old derogatory accounts, the date last active changes from say, six years ago, to the current month, and the seven-year clock starts all over again affecting credit scores for a much longer term.

To make matters even worse, the credit scores are weighted by how recently the derogatory accounts are reported. A one-month-old "Paid Collection" account does far more damage to a FICO score than a six-year-old "Charge Off." While it may seem ironic that making good on one's obligations can hurt a consumer's credit scores, it does.

A client in this situation may have a couple of effective methods available to then and at their disposal. If the client has the cash to pay off the old accounts, they should call the creditor reporting the collection account. It is important that they insist on speaking with a credit manager that has authority to negotiate final settlements. Once this authority individual is found, you should first offer a settlement of 70% or so (be flexible) of the outstanding balance due. This offer must be on the condition that the status of the account be reported as simply "Paid", not "Paid Collection" or "Paid was 60", etc., and the date last active remain unchanged. Make sure that you, the client receives this agreement in writing prior to making any payment.

It is important to note that the older the account is, the easier it is to negotiate such a settlement. The client should simply let the old accounts fade off the credit report with time.

A common myth is the impact of inquiries to your credit file on credit scores.

Inquiries fall under the general category "Pursuit of New Credit." Also in this category is "Length of Time Since Most Recent Account Established." I can assure you that two new credit-card accounts opened last month will do far more damage to a FICO score and credit scores than a few inquiries. Additionally, the entire category "Pursuit of New Credit" is fourth on a list of five categories that affect credit scores (which I outline below), and is estimated to carry a weight of 20%-30% in determining a score. Simply, inquiries, unless excessive and recent, have very little impact on credit scores.

Even more important is the way that mortgage inquiries are now handled. First, they have no impact on credit scores for thirty days (the same applies to auto loans). Additionally, all mortgage inquiries within a 14-day period count only as one single inquiry.

Because the score is a composite of all the applicant's credit information, no single factor like a late payment or a bankruptcy will be the sole cause of an unacceptable score. Scoring can be difficult to understand and explain to consumers.

This article is taken in part from a FICO newsletter by:

B. Thomas
The FICO Doctor
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