[M345]Measuring And Managing Credit Risk

The fact that you're reading this article shows you understand how important your credit scores are when it comes to your financial health.

But knowing that your credit scores are important is not enough...just like it's not enough to know what your temperature is. You have to know what “medicine" will make you healthier.

So, let me be very clear on two different ways you can increase your credit scores. When these two ways are combined they're a very powerful force to be dealt with.

The two primary ways to raise your credit scores are:

1. Managing your credit (in other words, things you can do yourself)
2. Removing inaccurate negative information from your three credit reports (usually best handled by a law firm that specializes in these matters)

In this article, I'll focus on the first way-managing your credit.

Managing your credit means a lot more than just paying your bills on time.

A change in how you pay your bills, when you pay your bills, when you apply for credit, what credit you apply for, etc...can send your scores sailing and impress your lenders.

However, when the above actions are carried out incorrectly they can send your scores crashing to the floor.

There's an art to managing your credit to increase your credit scores.

Did your parents teach you the right things about your credit?

Probably not...

You see, credit scoring didn't become widely accepted until the late 1980s. It's important that you understand most of what your parents taught you about how to manage your credit is wrong...because it doesn't translate into what works today.

Sad, but true.

Doing things the way your parents taught you would be the equivalent of buying a record player and trying to find a vinyl record of your favorite recording artist today...compared to buying an audio CD.

Our parents and grandparents weren't “scored."

We are.

When a credit check meant an index card and a handshake!

I can remember my father driving downtown to talk with his banker friend at Salem Bank in Goshen, Indiana. (Today the bank is called something else.)

What I remember most about my dad getting loans back then was that everything seemed to work on a "good ole boy" system.

Right or wrong...it seemed as though our local banker took Dad's reputation, character, church affiliation, and community involvement into the decision-making process.

Sure, the bank looked at Dad's credit history...but it wasn't like it is today.

Credit reports didn't become widely automated until the early 1980s. In fact, for a long time there weren't really any national credit reporting agencies. They were all small local credit bureaus called "merchant associations." The local merchants would share your payment history with each other.

These merchant associations ended up becoming small local credit bureaus. Through years of acquisitions, the small credit bureaus eventually became a part of what are now known as the three national credit reporting agencies.

Our local credit bureau in Goshen, Indiana back then wasn't even affiliated with a national credit reporting agency...and they kept our credit information on three-by-five index cards!

I remember back in those days Dad actually went to the credit bureau if he had questions about his credit. I'll never forget the cranky local credit bureau employee walking to a file box full of index cards and removing my dad's credit file. No computer...no internet...just file boxes and index cards!

That doesn't happen anymore.

The system is highly impersonal now. Credit scoring has taken the bias out of the lending decision.

Why our parents' advice about credit no longer works

My father died at the age of 55, before credit scoring became widely accepted in the United States and before my first book, Credit After Bankruptcy was published.

His sage advice to me was, "Pay your bills on time and everything will be OK."

And for the most part that was excellent advice, because that was all that mattered...before credit scoring was invented and became popular.

But today there's more to it.

The majority of what makes up your credit scores has nothing to do with how you pay your bills

How you pay (or don't pay) your bills accounts for only 35% of what makes up your credit scores.

Do the math.

That means that 65% of what makes up your credit scores has nothing to do with paying your bills on time!

Understanding where that 65% comes from and knowing how to properly manage these other factors is the key to increasing your credit scores-fast.

The good news is, within this 65% are actions that are largely within your control. For instance:

- Only you decide how much of a balance to leave on your credit cards each month.
- Only you decide how and when to apply for credit.
- Only you decide to work with mainstream lenders instead of finance companies.
- Only you decide if you tap your home's equity with a line of credit or home equity loan.
- Only you decide how many inquiries appear on your credit reports, etc.

You make these and other credit decisions every week. And these credit management decisions determine 65% of what makes up your credit scores.

Four quick actions you can take right now to increase your credit scores

1. Whenever you apply for mortgage or auto-related credit, always do it in a 14-day period to minimize the damage of the inquiries to your credit scores. These types of credit inquiries, if made within 14 days of each other, will count as only one inquiry in your credit scores.
2. Increase the credit limits on your revolving credit cards. (But make sure you don't increase your spending!)
3. Figure out a way to pay off your credit cards each month.
4. Only work with banks, credit unions or captive lenders that report to all three national credit reporting agencies. No finance companies! Pay close attention to the types of lenders that appear on your credit reports.