5 Credit Questions with Fair Isaac’s Barry Paperno by jim on September 23, 2008

Following my guest post on my good friend JD’s Get Rich Slowly about How to Prepare for Buying a Home, I was contacted by a PR firm asking whether I’d be interested in talking with Barry Paperno, consumer operations manager at Fair Isaac. Fair Isaac is most well know for developing the FICO score, otherwise known as your credit score, which is probably one of the the most important numbers you need to know prior to getting a mortgage. Since it was relevant, I shot over five questions for Mr. Paperno and he was kind enough to answer them (I’m emphasized parts of his answers that I feel are valuable).

jim: Barry, could you give us a little background about yourself and your role at Fair Isaac?
Barry Paperno: Prior to joining Fair Isaac in 1995, I served as Operations Manager with Experian, running their San Francisco Bay Area consumer assistance office. There we provided credit reports and counseling to consumers, investigated disputed credit items, and corrected credit reporting errors. At Fair Isaac, I’ve helped educate lenders, credit bureaus, and consumers on FICO scoring; while managing customer service operations for myFICO.com. I currently head up training and consumer education programs for Fair Isaac, and manage the FICO Forums online community at myFICO.com.
jim: What are some simple steps consumers can take to improve their credit score?
Paperno: Other than the obvious step of paying bills on time, reducing credit card debt is the single best step people can take to help their score. A scoring factor called “credit card utilization” plays a big part in FICO scoring. This calculation, expressed as a percentage, looks at the proportion of balances to credit limits on your credit cards. While the general rule is “the lower the better,” the ideal utilization percentage is under 10%.
jim: What is the biggest mistake people make when it comes to their score?
Paperno: By not educating themselves about credit reports and credit scores well in advance of applying for credit, people often make the loan application process much more stressful than it needs to be — particularly if errors on the credit report are resulting in a lower than expected FICO score. It’s important to understand that the credit bureau investigation process for correcting errors typically takes about 30 days to complete, and that your FICO score can’t change unless the credit information used in the score is corrected. So, if you’re going to be applying for credit, check your credit report and FICO score early on, so that if there’s an error you’ll have time to get the necessary corrections made.
jim: What are some common misconceptions people have about their credit score?
Paperno: A couple of the most common scoring misconceptions are: 1) if you pay off your credit card balances in full each month you will always have good score; and 2) if you have too much available credit your score will suffer:

  1. For most people, paying off their credit card balances each month is a great way to ensure a high score. For those who tend to max out their cards before paying them off each month, however, it’s a different story. The credit card balance showing on your last monthly bill is typically the balance that the lender will report to the credit bureau, so that’s what will show up on your credit report as the account’s balance. If your “credit card utilization” percentage is high as the result of having charged up to the limit before paying it, your score could be hurt. The solution here is to either make sure you have enough available credit so that your normal credit card activity doesn’t hurt your score, or cut back on your charging habits.
  2. The “conventional wisdom” for many years, particularly among mortgage lenders, was that too much unused available credit could indicate a high level of future risk to a lender if the borrower were to use that credit at a later date. As a result, for years people have been advised to close credit cards as one way to reduce this potential risk and raise their FICO scores. While it’s not hard to understand the rationale that went into this thinking, the results of extensive research conducted by Fair Isaac show that, on the contrary, a high amount of unused available credit is actually helpful for your score — along with a good payment record, low percentage of “credit card utilization,” and a sufficient length of credit history. My recommendation here is to simply leave those unused credit cards open.
jim: Do you have any recommendations for young people just starting to develop a credit history?
Paperno:
  1. Always pay everything on time, use your credit cards moderately so their balances stay as low as possible, and open new accounts only when necessary.
  2. Be aware that you don’t need a lot of credit to have a good FICO score. All you need is one account on your credit report that has been open for at least six months and that you have used at least once within the past several months.
  3. If you’re looking to obtain your first credit account, a “secured” Visa or Mastercard that’s reported monthly to the credit bureau is an excellent way to start developing a credit history. It works just like a bank card, with the difference being that the potential risk to the lender is reduced. The lender will set your available credit line equal to an amount you place on deposit in a savings account. This deposited amount can then be used as collateral for the debt should you fail to make the monthly payments. A secured card, when paid as agreed for a period of time, often later converts to an “unsecured” account with a higher credit limit and no deposit requirement.

Summary

The main takeaways that I got from interviewing Barry was that the majority of your score is determined by sound credit management - pay on-time, don’t get too extended, simply be responsible. However, at the edges, such as getting your score that extra ten points, depends on optimizing some of your decisions. For example, one of the more recently popular credit tips involving not canceling unused cards, a tip Barry mentioned. Keeping them open means your utilization is lower (which is good) and runs counter to the advice even the professionals would give.

Another idea, one that is intuitively obvious but often overlooked, is the fact that you could have mistakes on your report and those mistakes take up to thirty days to correct. If you need a loan within thirty days, it could be using a score that reflects inaccurate or incorrect information. This makes sense to people, it’s simply a matter of remembering it!

Remember, you get a free copy of your credit report from AnnualCreditReport.com from each of the credit bureaus every single year. It won’t include a score but it will include your history, which you can verify as correct. If you want your score, many hardcore credit score watchers from the likes of CreditBoards.com (quite possibly the most popular credit related forum with nearly 75,000 members) really like myFICO.com.


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Credit Score Demystified (sorta) by jim on February 03, 2005

Ever wonder what dings up that you credit score? Credit bureaus don’t give out the equation they use to figure your FICO score but through varying sources such as mortgage agents, credit card schemers, and folks who just keep an eye out on their credit score and see how it reacts to their behavior; we’ve gleaned a few tidbits that will teach you how your score is derived.

First things first, after you request your credit score you’ll actually get three of them: a FICO II Score, a New EMPIRICA Score, and a BEACON Score. They correspond to the three credit bureaus and their scoring equations:

  • Empirica Score credit score = Transunion credit bureau score
  • Beacon Score credit score = Equifax credit bureau score
  • Fair Issac / FICO Score = Experian credit bureau score

Hard Inquiries Vs. Soft Inquiries: Whenever you request credit (apply for a new credit card, try to get a mortgage or car loan, etc.), the institution extending you credit will want to get your score and assess your history in terms of risk. High score means safe and safe means low interest rate. They will pull a ‘hard inquiry’ that is recorded on your history and is ‘negative.’ A lot of hard inquiries means either you’re cavalier towards applying for credit or you’re trying to get a lot of credit very quickly, both cases are bad. A soft inquiry is the result of an informal look at your history, typically when you view your own credit or if someone else takes a peek. These aren’t as bad because they don’t mean that you’re looking for credit, it just means you or someone else just wants to know about your history to perhaps send you an offer. You can opt out of soft inquiries by telling each of the big three bureaus.

Lines of Credit History: History is only good if it’s old, we’re talking minimum 3+ years. Knowing you’ve been current on loans for three years is more meaningful than knowing you’ve been current for three months. Usually credit card companies won’t even give notice of late payment unless you’re 60 to 90 days late, that’s because they know someones people miss payments by accident.

Percent Utilization: “Keep it under 25%” is the maxim you should follow but if you let it slide to 50%, it’s not as bad as hitting 70%. If you have $10,000 of credit, keep your percent used under $5,000 or it looks like you’re in trouble. This is why requesting increases in your line of credit is key because it will decrease your utilization without dinging your history with a hard inquiry.

Types of Credit: Most college graduates will have large college loans outstanding, which appear on the record, and institutions know it. If you have a high utilization but it is predominately college loans, they’re typically okay with it so it won’t negatively impact your score as badly as if it were credit card debt. Part of the reason is the relatively low interest rate when you consider some people are paying over 25% interest on credit card debt.

Bottom Line: When making a financial decision, don’t base it on how it will affect your score, make it based on how it will affect your wallet/pocketbook but keeping in mind that your score may be affected. It’s like doing something for the tax break, it’s not worth it. Pay off your credit card debt because of the astronomical interest rate and don’t make that extra mortgage payment in lieu of it. And always stay current.

Update: (2/24) Added the three types of scores and which bureau they correspond to.


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