True Credit Secrets
Figuring out exactly how credit scores work is problematic. Like
nuclear fission, learning Chinese and setting the clock on your
DVD player, credit scoring is not something that most people can
easily master.
In the complicated world of credit scores there is one fact that
pretty much everyone assumes is true: late payments are bad for
your credit scores. Not only are late payments bad, but they are
also assumed to be one of the worst things you could do to your
scores. The first sign of a late payment on your credit reports
signals impending credit doom, right? It turns out that this
isn't exactly the case after all.
There are thousands of slightly different credit scoring models
used today, each with a different purpose and formula. The most
common credit scoring systems are set up to predict only one
thing: how likely you are to have a 90 day late payment or worse
in the 24 months after your score is calculated.
Credit scores are used by financial institutions, insurance
companies and utility companies as an efficient way to predict
how risky a customer you will be. If your credit score is low,
it indicates that you are more likely to make late payments or
file costly insurance claims. In turn, this means that the
creditor is more likely to lose their investment by lending you
money. Once you understand that credit scores predict this
specific behavior, it's a lot easier to figure out the best way
to manage your credit.
Because scoring systems are so focused on predicting whether or
not you'll go at least 90 days late, surprisingly, an old 30 or
60 day late payment is actually not that damaging to your credit
scores as long as it is an isolated incident. Only when your
accounts are currently being reported 30 or 60 days past due on
your credit reports, will your credit scores plummet
temporarily.
If your 30 or 60 day late payments are an infrequent occurrence,
this kind of low level late payment will damage your credit
score only while it is being reported as currently past due.
They shouldn't cause lasting damage to your credit score after
this period passes unless you make 30 or 60 day late payments on
a regular basis. In this case, the fact that you are habitually
late with your payments will cause long term damage to your
credit scores.
It's a whole new ballgame once you have a 90 day late payment,
however. If you have been over 90 days late (even just once),
the credit scoring models consider you much more likely to do it
again. One 90 day late payment will damage your credit for up to
seven years. From a scoring perspective, a single 90 day late
payment is as damaging to your credit scores as a bankruptcy
filing, a tax lien, a collection, a judgment or repossession.
Being 90 days late causes you to be viewed as a possible "repeat
offender" and a higher risk to creditors. Here's a summary of
how late payments impact your credit scores:
30 days late - This record will damage your credit scores only
when it is reported as "currently 30 days late." The exception
is if you are 30 days late often. Otherwise, a 30-day late
payment will not cause lasting damage.
60 days late - This record will also damage your credit scores
when it is reported as "currently 60 days late." Again, the
exception is if you are 60 days late often. Otherwise, it will
not cause long term damage.
90 days late - This record will damage your credit scores
significantly for up to 7 years. It doesn't make a difference
whether or not your account is currently 90 days late. Remember,
the goal of the scoring model is to predict whether or not you
will pay 90 days late or later on any credit obligation. By
showing that you have already done so means that you are more
likely to do it again compared to someone who has never been 90
days late. As such, your credit scores will drop.
120+ days late - Late payment reporting beyond the initial 90
day missed payment does not cause additional credit score damage
directly. However, there is an indirect impact to your scores.
At this point, your debt is usually "charged off" or sold to a
3rd party collection agency. Both of these occurrences are
reported on your credit files and will lower your credit scores
further.
If you continue to miss your payments beyond 90 or 120 days, the
following records may also harm your credit score:
Collections - Collections are the result of late payments. There
are two types of collections; those that have been sold to a 3rd
party collection agency or those that have been turned over to
an internal collection department. Regardless of which one shows
up on your credit reports, your scores will suffer.
Tax liens - Tax liens are obviously not preceded with late
payments on any sort of account. However, when tax liens are
reported on your credit files they have the same negative impact
to your scores as any other seriously delinquent account. And,
just because you pay off the tax lien or have it "released"
won't increase your scores.
Settlements - Settlements are deals made between you and a
creditor who is trying to collect a past due debt. Normally, you
and the creditor would agree on an amount that is less than what
you really owe them. Once you pay them, they consider the matter
closed and paid off. However, they will report that you have
made a settlement for less than your contractual obligation.
This will hurt your scores as much as any other serious
delinquency.
Repossessions or foreclosures - Having a home foreclosed upon or
a car repossessed are both considered serious delinquencies and
will lower your credit scores considerably for up to seven
years. The assumption normally made by the consumer is "hey, I
gave the home or car back to the lender, why are they going to
show me as delinquent?" The answer you'll get from lenders is
that you signed a contract with them to buy a home or car and
pay it in full over a period of time. You failed to do so
therefore they consider you to be in default of your agreement
with them and will report this on your credit reports.
Remember, the goal of most credit scoring models is to predict
whether or not you will go 90 days past due or worse on any
obligation. What's missing? The scoring models are not designed
to predict whether you will default for any specific dollar
amount. As such, having a 90 day past due of only $100 is as bad
as having a 90 day past due of $10,000. The same goes for low
dollar collections, judgments or liens. The dollar amount
doesn't matter. The fact that you paid late is what's most
important in the eyes of a credit scoring model.
Now that our late payment secrets have been revealed, let's look
at what it means to you. You should still avoid making late
payments whenever possible. But we now know that one 30 or 60
day late payment isn't the end of the world. Since 90 day late
payments are the real credit score busters, you should avoid a
90 day late payment at all costs.
If you already have a 90 day late payment record on your credit
history then your scores are already suffering. Be certain that
the information is being accurately reported. If it isn't then
you have the right to dispute it with not only the credit
reporting agencies but also with the lenders who reported it.
Your goal is to have the item corrected or removed, especially
if it is in error. Once removed or corrected your credit scores
will immediately recover.