3 Important Rules You Must Know To Have Perfect Credit

When it comes to credit, there are three basic – yet all-important – rules you need to know if you want to achieve the highest possible credit rating. These are rules that banks and creditors, credit reporting agencies, and credit-scoring companies tell you explicitly: in their consumer publications, on their websites, and in a variety of communications with you. In a nutshell, here are the three dominant written rules of the credit world:


1. There is a specific formula that governs your credit score.
2. All debt is not created equally.
3. The fine print counts too.

While virtually every adult in America has access to these three written rules, the majority of people have never taken the time to fully apprise themselves of these rules – let alone fully understand their implications. That’s a pity, because knowing these basic written rules is critical to understanding the world of credit and achieving perfect credit.

So let’s start with the first written rule. The formula that governs the most widely-used credit score is calculated by Fair Isaac Corp., the company that creates FICO credit scores, which range from 300 to 850 points. The higher your score, the better your credit.

Here is The Formula That Governs Your FICO Score

1. Payment History: 35% of your score
2. Amounts Owed: 30% of your score
3. Length of Credit History: 15% of your score
4. New Credit: 10% of your score
5. Types of Credit in Use: 10% of your score

Based on this information, as well as other advice FICO freely disseminates on its website (http://www.myfico.com) and elsewhere, you can draw some good general conclusions about what actions can help your credit – and what could hurt it. For example, to increase your credit scores:

• Pay Your Bills on Time
• Payment track record is the largest component of your FICO score
• One late payment can drop your FICO score by 50 to 100 points or more

• Maintain Low Credit Card Balances
• Don’t “max out” any cards
• Try to not to use up too much of your available credit limit

• Keep Your Older, Established Accounts Open
• Longer credit history is scored favorably
• Closing accounts can sometimes lower your FICO credit scores

Let’s look now at the second written rule concerning your credit.

All Debt is Not Created Equally

Debt is such a huge problem in America: Mortgage loans. Credit cards. Student loans. Automobile loans. You name it – we’ve got it. But from a credit standpoint, please understand that the type of debt you’re carrying matters tremendously. I know this because the credit industry has told us explicitly that some debt is considered “bad” debt.

What counts as “bad” debt? For the most part it’s credit card debt. Yes, if the balances on your Visa, MasterCard, American Express or Discover cards have gotten out of control, you’re likely doing some serious damage to your credit. But other types of debt aren’t good for your credit rating either – like department store charge card you opened just to get 10% off your purchase, or the retail credit account you got to buy household furniture.

Your FICO score is strongly tied to the credit card debt you have, because, (as you may recall from the FICO formula), 30% of your credit score is based on the amount debt you have. Did you think that 30% pertained to your mortgage debt or student loans? Although those debts are examined in other ways during FICO’s calculation, the debt FICO is overwhelmingly concerned with is your credit card debt. Let me explain why.

The FICO scoring system evaluates three forms of debt in your credit files:
• mortgage debt
• installment debt
• revolving debt

Mortgage debt is very straightforward. This is the house note you have on your primary residence, the home equity loan or home equity line or credit you may have, or perhaps the mortgage you pay if you’re lucky enough to have a vacation home or investment property. In short, if you own a piece real estate, and you have a loan for which the house is collateral, you have some form of mortgage debt. Generally speaking, this is the most highly-rated form of debt in the FICO scoring system.

Next up is installment debt. This refers to one-time loans you took out that you are paying off over time, by making fixed payments at regularly scheduled intervals. For instance, assume you received a $10,000 student loan five years ago and you are now repaying the loan. You may be making $125 payments every month, due on the 15th of the month. In this case, your student loan balance does one thing: it declines every month. Part of your $125 a month payment goes toward knocking down the principle balance and part of it goes toward paying interest on the loan. The same deal applies with car loans. Lenders know that balances on installment loans aren’t going to rise. Thus, installment loans are “good” forms of debt, from a credit-scoring standpoint. They are unlikely to hurt your credit ranking, as long as you pay on time.

The last category, however, revolving debt, represents a potential minefield for lenders – and you – in many ways. Revolving debt, such as credit cards, is the riskiest form of debt from a lender’s standpoint, because the lender has far less control over this debt, and you call the shots on it in many ways. Assume, for a moment, that you have a MasterCard with a $5,000 credit limit. Your balance this month might be $1,900. But last month the balance was $1,255, and the month before that it was $1640. As it stands, neither the lender nor FICO has any way of knowing how much you’re going to charge in any given month. They can try to predict it – and they do try. But for the most part, they can’t know with certainty whether you will charge $30, $300 or even $3,000 on your card in the following month.

There is another reason why revolving debt isn’t scored favorably in the FICO scoring model: No one knows exactly how much you will pay on your credit card debt. You might decide to make minimum payments, you may opt to pay $500 toward the overall balance, or you may feel flush with cash and decide to pay off the entire balance.

Lastly, consider that installment loans, such as auto loans, are secured loans. If you don’t pay what you owe, the lender can come to your house and repossess the vehicle. A credit card, in contrast to a car loan, is an unsecured form of debt. If you charge $800 on your Visa card for that flat-screen TV you just had to have, what is the bank going to do if you don’t pay your credit card bill? They can’t come in your house and snatch that 40-inch TV off the wall. So they’re mainly stuck with reporting you to the credit bureaus if your payment is 30 days or more late. Of course, your account could go into collections, or they could get a judgment against you if they felt it was worth the time and money to go those routes. But the concept you need to understand is that secured loans – whether it’s on real estate or automobiles or something else – are always less risky to lenders than are unsecured debt, like credit cards. As a result, that unsecured debt filling your credit report, courtesy of those credit cards in your wallet, will always get judged more severely in the credit scoring world.

The Fine Print Counts Too

The last written rule concerning credit that is of utmost importance is the one where you’re told, in no uncertain terms: The fine print counts too. In fact, it often counts more than the “headlines” or promised benefits of any deal you encounter. How do banks, credit card companies, retail creditors and others tell you that the fine print counts? It’s when they make statements like these:

• Terms and conditions
• Certain restrictions apply
• Consult rules for further information
• Complete details listed below
• Full terms, rates, fees, and other costs on back
• Limitations and exclusions
• Please see application for all details
• Pricing and terms

So now you’ve been warned: If you ever see language like the statements listed above, that’s your cue that you need to read the fine print for any product, service, or any deal you’re thinking about taking. In many cases, if you took the time to read the fine print, all sorts of red flags would pop up, telling you to slow down and fully understand what you’re about to do.

Oh, if I had a dollar for every time I’ve heard people complain (myself included) about some aspect of their credit and debt that was tied to fine print. I’d be a very wealthy woman indeed. Here’s what happens in many of these cases. We get wowed by a marketing message or so vested in getting a certain deal that before we know it we’re caught up in a transaction where we don’t understand the fine print. Or worse, we don’t bother to even read it. Or perhaps we ignore the fine print thinking that only the bold-faced message counts, especially when it seems to work in our favor. Like the balance transfer feature promotion for a new credit card that says “0% for balance transfers.” But after you read the fine print of this seemingly attractive offer, you find out that the balance transfer fees are exorbitant, or that the interest rate on standard purchases is sky high.

It’s been said that “The big print giveth, and the little print taketh away.” In many ways, that’s true. Here’s why the fine print counts too – often more than the bold-faced advertising or marketing message you may have seen in an offer.

The fine print is where you’ll learn what you must do to qualify for something.

The fine print is where you’ll find out when the benefits promised apply, when they don’t, and when they can change, expire, or be revoked.

The fine print is where you will discover all the restrictions, exclusions and other rules that impact a deal.

Therefore, you must always think about any loan, credit offer, agreement or special deal as having two parts: the hook and the fine print. The hook is designed to do just that – “hook” you into saying “Yes.” The hook is the bold-faced advertisement, or the marketing message that grabs your attention. It will be something enticing, like “No Money Down,” “Low 4.9% APR,” “Only $9.95” “Cash Back Bonus” or “Free.” The fine print invariably has less-appealing language. It covers the nitty-gritty details of the offer, including its limitations, critical information about pricing, fees, terms and conditions. The hook is always prominently displayed. But the fine print is most often displayed in small type, or perhaps is simply not as pronounced, and is usually located far at the end of, or in back of, an offer or agreement. In the case of online offers, the fine print is typically one or more click away from the hook. While the fine print may be more difficult to read, harder to find, and sometimes complex to understand, it is there nonetheless, and it’s your responsibility to read it. If not, you could put your credit standing and your finances at serious risk.

This article excerpted from Perfect Credit: 7 Steps to a Great Credit Rating, by Lynnette Khalfani-Cox. All rights reserved.

By: themoneycoach

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Lynnette Khalfani-Cox, The Money Coach, is a personal finance expert, television and radio personality, and the author of numerous books, including the New York Times bestseller Zero Debt: The Ultimate Guide to Financial Freedom. For more tips on managing credit and debt, visit Lynnette’s website at: www.TheMoneyCoach.net. Or you can visit her blog at themoneycoach1.wordpress.com/.