Question: Hi Chris: Thanks to you and Tess for your informative show. It's appointment radio for me on weekends. :)
Here's my question: I've worked to get my finances in order and bring my credit score up over the past several years. Currently I have only one credit card with a very low limit, which I can and do pay off in full each month. I have no student loans or other debts and no mortgage. I've been contemplating trying to buy a house for the first time this year and have been watching my credit score through Equifax. This month when I pulled the report, the summary told me that one of the factors that could work against me was that I had had no new credit or loans in several years.
I had intended to put off buying a car for another year or so, but could afford it now, though it would mean saving a little less each month. I want to get the best interest rate possible when I finally get a mortgage, so I've been paranoid about adding any new debt. Has being prudent held me back? Could taking out a small loan (less than 10k,) for something like a car, and making on-time payments actually help my score in advance of trying to get a mortgage? And if it lowers my score initially, how much of a penalty would it be? And at what point in the loan is it actually helpful? 3 months in? 6? a year? Thanks, Kerri, Washington, DC
Answer: When it comes to question like this my starting place is good savings and debt management practices. The peculiar dynamics of the credit scoring business comes second (or third or even farther down the list). My basic belief is good savings and debt habits will pay off in all economic and financial seasons, and those sound principles will pay off in a good credit score. Not everyone agrees with me, and their personal finance advice is more tailored toward manipulating credit score higher. I don't agree. What's good for the profits of the credit reporting and credit scoring industries is not necessarily good for your personal fiscal health.
We're in a recession. It's unclear how deep the recession will go and how long it will last. You've already gone through the tough slog of getting your personal finances in order. You pay off your credit card bill in full every month. Bravo. I would not take out on unnecessary debt and create a more fragile balance sheet in an attempt to boost your credit score. My fear is that the strategy could backfire on you badly.
What's more, my educated guess is that you'll be fine when it comes to buying a home. Remember, there is a range to credit scores and if you keep paying off your bills on time you'll be pretty high up. Take this example drawn from the FICO website. The key assumptions: The mortgage loan is for $150,000 and the borrower is making a 20% down payment on the home
FICO Score Mortgage Rate
720-850 4.760 %
700-719 4.885 %
675-699 5.423 %
620-674 6.573 %
The reason for the "NA" or Not Available for the two lowest score levels is that borrowers with such a low score and damaged credit can't qualify for better loan terms.
It would be much better for you to spend the time researching the home you might buy, and the neighborhood you want to live in. Remember, you have a lot of negotiating power in this market. You should visit with a bank loan officer or credit union lender to see what rate you qualify for currently.
Let us know how it goes for you.