Credit Scores – Avoid an Own Goal
Personal credit reports and credit scores can be a critical piece to securing a commercial loan or a better interest rate, even though ironically commercial loans do not appear on your credit report. For commercial credit, say a commercial mortgage on an investment property, or a construction loan for a development project, even though you may have to personally guarantee the debt, this debt will nonetheless not appear on your personal credit report.
It may seem absurd to a professional real estate investor or developer, who has amassed tens of millions of dollars in performing commercial loans with a long history of sound payment history, to get tripped up by missing by a few days a small monthly payment due on a credit card or auto loan. Yet this happens all the time. The other aspect that can trip them up is not using enough personal consumer credit. The same investor with tens of millions in performing commercial debt might only have $10,000 in consumer debt and therefore be assessed a lower credit score.
By not paying attention to the smaller and less significant debts in your life, these much smaller obligations can cost you a significant amount of money within your commercial enterprise in higher interest rates or declined loan requests. On the plus side, with commercial lenders, unlike consumer lenders, it is easier to explain away one-off indiscretions or old non-relevant matters from the past with a detailed explanation.
The easiest way to keep your credit score healthy is to always pay your consumer debt on time, never miss a payment, keep using your credit even minimally, and don’t close any credit lines. It’s curious to find that paying off a term loan, an auto loan, or closing a credit card account can actually be a negative to your score. In the borrower’s eyes, it should be a good thing, they just paid off in-full an outstanding debt, however in the credit bureaus' eyes you now have less credit available to you as if a lender has cut you off for a negative reason. The best rule of thumb is to keep all credit line balances below 30% of the approved credit limit, but ideally keep it below 10%. Do not keep all your credit lines at zero though, the algorithms like to see some activity.
You should have auto-pay set up on all accounts so you never miss a payment while on vacation or preoccupied with business. Auto-paying the full balance each month is best, but if you are juggling cashflow from month to month, at the very least you must set the auto-pay to pay your minimum payment amount. If cashflow allows, add a supplemental payment on top of your minimum. Never sacrifice the minimum payment due just to conserve cash for elsewhere as the repercussions can cost you dearly later in a bad score.
In the event of a derogatory item appearing on your report, review it as quickly as possible and dispute it with each of the three credit bureaus and with the credit institution concerned. The bureaus are obliged to research and correct any incorrect items. On the other hand, if the negative item is correct, there is no magic solution to expunge it from your report. The best healer is time. Make sure no other negative items occur and keep your balances low, and pretty quickly your score will improve.
There are countless credit repair companies promising to increase your score and remove derogatory items from your report. Most of these companies cannot fulfill their promises if the negative items are correct. Many of these companies are operating as fee-collecting machines preying on the weakest and most vulnerable. In fact, it is against the law to collect credit repair fees upfront on the promise of correcting negative credit issues, yet most companies continue to do so. The credit repair industry collected $4.4 billion in 2022, spread over an estimated 60,000 credit repair businesses.
The credit score most commonly used is the FICO score, so named after the data analytics company Fair, Isaac & Company which created it as a scoring system back in 1989. The three main credit bureaus are Experian, Equifax, and Transunion, and they all maintain their own proprietary scoring system. The algorithms they use to calculate their scores are not disclosed and are maintained as Trade Secrets. The credit reporting industry generates $15 billion in fees annually, mostly from lenders and credit institutions requesting reports on current & potential customers. The bureaus have also stepped into the consumer credit monitoring business, being distinct from the repair business, by promising that consumers can monitor and correct any issues, and provide advice & suggestions to help increase their score.
An individual’s credit score is weighted from the following areas:
35% - Payment History (late payments 30+ days, keep to zero)
30% - Amount of Debt (revolving utilization, keeping under 30% of credit limits)
15% - Length of History (average age of accounts, the longer the better)
10% - Amount of New Credit (new credit lines, keep to a minimum but adding new credit is positive)
10% - Credit Mix (mix of credit types, having credit cards, auto, and home loan mix helps)
Don’t let one mishap on your consumer debt, or a lender mistake for that matter, cost you a fortune on your next commercial loan. Set yourself up with a credit monitoring service and always have your consumer debts on auto pay.
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michael@mulcahycapital.com
+1-617-861-2042
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