Getting Back Into the Black

   The FICO score is the most commonly used credit score that lenders use to determine what kind of rates and credit you qualify for.  FICO scores range from 300 to 850.   Do you know what your FICO score is and what it means to you?   Knowing your score and working to improve it, can mean the difference between paying $1,678 for a $300,000, 30 year fixed rate mortgage or paying $2,680 a month.   I can think of a lot better things to do with $1,002 dollars a month than to give it to a lender to make up for my poor credit decisions.  

   Understanding your score   Here’s a quick rundown down of the scores.

Over 750 is excellent

720 to 750 is very good

660 to 720 is acceptable

620 to 660 is uncertain

620 and under is risky

Understanding how FICO is scored will let you know what you need to do to improve your score.  The biggest factor is payment history, it makes up 35% of your score.  Payment information on credit cards, installment loans, retail accounts, mortgages, etc.   Bankruptcies, tax liens, collections, judgements, late payments, etc make a huge impact on this part of your score.   They also look at how many late payments you have on file, how long they were late and time since they were reported.   The next most important category is the amount you currently owe creditors.  This makes up 30% of your score.   They look at the ratio between  the amount you owe and the amount you have available to you.  The higher this ratio, the better, meaning it’s best to carry low balances.  The length of your credit history counts for 15% of your score. They’re looking at time since accounts were opened and time since activity on the accounts.  New credit and types of credit used each make up 10% of your score. 

   How to optimize your FICO score

The most important thing you can do, is to pay your bills on time.  If you have missed payments, you need to get caught up and start paying them on time.  The longer you pay them on time, the better your score will be.  Paying off a collection will not remove it from your credit report.  It will still stay on your credit report for seven years.   Keep the balances on your credit cards low.  It’s better to pay down your debt on all of your cards then to move it to one card. Owing the same amount but having it on fewer  open accounts can lower your score.  Don’t open up a bunch of accounts that you don’t need, many experts say you only need a few credit cards to have a great score.  If you haven’t had your credit card or loan for very long, don’t open a lot of accounts at the same time.  New accounts bring down the average on your credit history length and can look risky if sign up for too many.  

   Why the Fico score is important to us

  One of the biggest goals my husband and I have is to buy a house.   We want to make sure we do it the right way.   Rebuilding my husband’s credit and establishing my credit has become an important process.   Due to our credit mistakes and my husband’s bankruptcy, we are estimating that will take two years to get our credit where it should be.   There are no easy fixes.   It takes a very short time to damage your credit and a fairly long time to rebuild it.    We could get a mortgage in a few months but we’d be paying so much more that it would be a dumb, illogical choice.  So, instead we will continue to put money into our savings accounts to use as a substantial down payment when our credit will get us a good rate.    Be informed, don’t pay more than you have to.   Get your score and more information at www.myfico.com.  You may have heard something about a new credit scoring system.  It’s called VantageScore, but at the time of this article, FICO is still the most widely used.  

The first step for my family to get our spending under control and to start saving money was to determine where our income was being spent. It took about 2 hours total to get all of this information and then get it down into an easy to read format.

1. Calculate your income after taxes, this includes any paychecks you receive along with any other sources of income.
2. Make a list of all of your expenses. Anything you spend money on monthly needs to go on here. examples: rent/mortgage, gasoline, insurance, online services, groceries, dining out, etc.
3. Take all of the expenses you have written down and divide them into two categories. Discretionary (you dont HAVE to spend this money but you do) and Non-Discretionary (money that has to be spent: groceries, rent, gasoline, etc)
4. Add up your monthly expenses and subtract that total from your monthly income. If you end up with a positive number then you are already on the right track. If you have a negative number, you are spending more every month than you make and are forcing yourself further and further into debt.
5. Make adjustments to your spending to increase the surplus you have after all your bills are paid. This may include not stopping for a latte every morning or reducing the amount of channels on your cable bill to get a lower bill, or even something as simple as taking food to work for lunch instead of dining out every day.
6. Lastly, you want to make sure you review your budget every month. Keep track of your expenses for a month either through your bank’s online services, a notebook, or whatever system works for you. After a month of living on your budget, compare your actual expenses to projected expenses and see what area’s need more work.

Once you have yourself trained to live within the budget you have created you can start planning how you are going to save your surplus and what goals you want to set for yourself.

I have several financial goals I want to hit before the end of the year. 

 My #1 goal is to pay off at least half of my truck balance.  Its at a 10% interest rate and is not due to be payed off until 2011, if I can keep up with my aggressive payment schedule (an extra $2400 - $3600 this year) I can get it payed off by 3rd quarter of 2009.  It would save me about $800 and cut my loan term by almost two years.

My other goals are:

Emergency Fund: 4000
I’ve never had an emergency fund because I never knew I needed one until I set out to to take control of my finances.

New Baby Savings: 3400
My wife found out last month that she may be pregnant.  We’ll get the official word from the doctor next week.  In anticipation of that, I am putting the money directly into an ING savings account at the beginning of every month.

 Every other dime we have will be going into a savings account for our first home purchase some time in the next 3 years.  I need to start rebuilding my credit score before I can apply for a home loan, so I figured I may as well be ready once my score is where it needs to be.