The recession has hurt many people's credit scores. How to fix it?

By Kimberly Lankford
Special to The Washington Post
Saturday, March 6, 2010

The recession may have done a number on your credit score, even if it spurred you to reform spendthrift ways and cut up your credit cards. For many, the drops have come at the same time that lenders have tightened their standards and demanded higher scores to get the best interest rates.

Even if you haven't had major credit troubles, like a foreclosure, your score may have dropped if you missed a few deadlines or boosted your balances when cash was tight. A study by credit bureau Experian found that average credit card balances in the top tier of borrowers are 22 percent higher than they were a year ago.

And some people's scores have suffered even though they thought they were doing everything right. Credit card companies have been lowering credit limits and closing accounts in an attempt to minimize their risk -- 13 percent of people surveyed in January by Credit.com said their card company had lowered their credit limit over the past few months, and 11 percent said a card company closed their account.

Your credit score is the numerical summary of the information in your credit reports, which lenders use to predict the likelihood that you will repay your loans. The most common score that lenders use is the FICO score, which ranges from 300 to 850. The higher the score, the better. The median score tends to run between 710 and 720.

Your credit score can have a surprisingly large impact on your life -- affecting not only interest rates and terms made available to you, but your ability to get an apartment, cellphone service and affordable car insurance. And this magic number can make or break your ability to qualify for a good mortgage deal.

"It has become a very score-driven industry," said John Ulzheimer, president of consumer education for Credit.com. You generally need a credit score of at least 620 to qualify for a loan that can be bought by Fannie Mae or Freddie Mac, which gives you a wide range of mortgage options. Borrowers with low credit scores have always found the Federal Housing Administration mortgage program more welcoming, but even the FHA is growing more demanding about scores. The agency has proposed that, starting this summer, the program allow only borrowers with scores above 580 to qualify for a loan with 3.5 percent down payment. Those with scores below 580 would be required to make down payments of at least 10 percent.

Brad Sherman, vice president of residential lending for Nationwide Mortgage Services in Rockville, said most people need a 740 or higher to get the best rates these days. For people with scores below that level, Fannie and Freddie generally base rates on 20-point brackets of credit scores -- the lower your score, the higher your interest rate and the higher amount of equity, or cash down payment, the lender will require. "Having more equity in a house could counteract a poor score, but you still need to have at least a 620," Sherman says.

Just under one-third of your score is based on the amounts you owe. A key element is the portion of your available credit that you've used, called your "credit utilization ratio." Your available credit shrinks when your card company decreases your credit limit or closes an account. If the balances on your other cards remain the same, then your utilization ratio goes up and your score can go down.

There's good news, however, for homeowners whose home-equity credit lines' limits have been lowered because of declining property values. Such limit reductions do not affect credit scores.

Even a relatively minor score change can make a big difference in your interest rate. According to the FICO Web site, borrowers with scores of 760 to 850 paid average rates of 4.613 percent on 30-year $300,000 mortgages this week, while those with scores of 660 to 679 paid average rates of 5.226 percent -- translating to a payment difference of about $40,300 over the life of the loan. (You can run your own numbers at http://www.myfico.com.)

No matter what happened to your score during the recession, taking the following steps a few months before you apply for a mortgage can improve your score and translate into big savings.

-- Check your credit reports from all three credit bureaus, Equifax, Experian and TransUnion. Your credit score is based on information from your credit reports, and errors can unfairly hurt your score. You can get free credit reports from all three bureaus every 12 months at http://www.annualcreditreport.com, or you can order them directly from the bureaus for about $10 each. It's important to check all three because each can be slightly different, and an error can appear on just one version.


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