Tuesday, December 29, 2009

How fast does your credit score recover from your goofs?

Time heals credit wounds, but how soon and how well remain a mystery

By Jeremy M. Simon

Credit Score Report
Reporter Jeremy M. Simon
Jeremy M. Simon covers credit scoring and other issues as a staff reporter for CreditCards.com.

Ask a question.

'Credit Score Report' stories

Question for the CreditCards.com expert

Dear Credit Score Report,
I know if I have even one 30-day late payment, my credit score drops. Question: How long is the penalty? When can I expect to see my score increase again? -- Mike

Answer for the CreditCards.com expert

Hey Mike,
Experts say you can expect a late payment to hurt your credit score for seven years, with your score gradually recovering over that time frame as you make smart borrowing decisions -- though exactly how much and how fast your score recovers isn't entirely clear.

The federal Fair Credit Reporting Act says that negative items can only appear on your credit report for seven years, but it doesn't say how the credit industry should treat the impact of those items after they happen. That vagueness, combined with the secrecy and complexity involved in credit scoring, mean that it's tough to say exactly how a borrower's credit score will recover from a late payment. Still, provided the borrower makes smart decisions following a slip-up, time will heal those credit wounds.

"Every consumer's situation is different, but generally speaking, the impact from a negative item, such as a late payment, will lessen as that item ages" says Steve Katz, spokesman for credit bureau TransUnion.

While FICO, creator of the most-widely used scoring model, largely keeps the details of its scoring model a secret, we do know the approximate damage a late payment will cause. FICO pulled the curtain back a bit on its scoring model recently when it acknowledged just how much certain credit mistakes can hurt a borrower's credit score. For example, in the case of two hypothetical consumers, FICO said that a 30-day late payment would reduce a FICO score of 680 by 60 to 80 points, while an identical late payment would reduce a FICO score of 780 by 90 to 110 points. (For more on this topic, see our story on FICO's damage points.) You can run FICO's credit score simulator to get an idea of how much damage various mistakes, including a late payment, may cause to your own credit score.

But when it comes to the recovery process, it's still largely a mystery. FICO spokesman Craig Watts says your score will recover over time because the scoring model factors in when you made your errors, how bad they were -- for example, was your payment late by 30 days or by 90 days? -- and how often you made them. However, FICO's mathematical formula can't predict exactly how fast your score will improve. Watts says there are simply too many changes that can happen over time in a consumer's credit report, both due to the cardholder's own actions and changes that are beyond the consumer's control. For example, you wouldn't have any control over the continual aging of your existing accounts.

Still, FICO's Web site gives some clues as to how a credit recovery might play out. FICO says that for negative items on a credit report, "a collection that is 5 years old will hurt much less than a collection that is 5 months old." Please note the use of the phrase "much less" to signal that five years out from your late payment, its impact will be seriously lessened.

In discussing a foreclosure's impact, FICO says "it's a common misconception that it will ruin your score for a very long time. In fact, if you keep all of your other credit obligations in good standing, your FICO score can begin to rebound in as little as two years." Based on the fact that a foreclosure is much more damaging to a credit score than a late payment, it would make sense that in your case, your FICO score would also begin to recover within two years of your late payment.

Although FICO leaves it somewhat unclear what a recovery from score damage looks like, the steps you need to take to recover from that mistake are clear: "The best way to minimize the impact is to catch up on the payment and then continue to make all of your payments on time," says Rod Griffin, director of public education with credit bureau Experian.

By always making on-time payments from now on, as well as keeping debt levels low and only taking on additional lines of credit when necessary, that late payment will become just a minor slip-up on the road to an improved credit score.

Good luck!

-- Jeremy

Instant in-store credit card offers in danger of extinction

New credit card law requires retailers to ask customers for income, other data

By Connie Prater

Instant in-store credit card offers -- you know, the ones pitched by perky sales clerks offering 15 percent off your purchase if you sign up now for a store credit card -- may disappear in malls and retail outlets across the country come February.

Instant in-store credit card offers may dissappear in malls and retail outlets

WHAT'S HAPPENING: The Federal Reserve has proposed rules requiring credit card issuers, including retail stores that offer instant in-store credit, to assess customers' ability to pay card loans before issuing them credit cards.

WHY IT'S IMPORTANT: Retailers say instant credit card offers won't be possible if consumers have to provide paycheck stubs or other income information at the cash register.

WHAT'S NEXT: The Fed must issue final rules sometime before the Feb. 22 startup of the Credit CARD Act. The Fed won't say whether it will revise the rules to address retailers' concerns.

That's because a provision in the new credit card reform law says that starting Feb. 22, 2010, credit card issuers must consider an applicant's ability to repay the card loan before issuing a new card or increasing the credit limit on an existing account.

The measure has thrown a speed bump into the instant credit approval process and has the retail world in an uproar. Some of the biggest names in retail -- Saks Fifth Avenue, Macy's, Best Buy and Lord & Taylor -- are objecting to new guidelines proposed by the Federal Reserve Board. If given final approval, they say, it could kill the retailers' lucrative in-store instant credit card plans.

A speed bump to instant credit?
"We think it's pretty serious," says Mallory Duncan, senior vice president and general counsel for the National Retail Federation trade group. The Fed wants to require lenders to review income or asset information -- such as paycheck stubs or investment statements -- of people applying for new credit cards. The problem: Instant credit won't be so instant if consumers must fork over paycheck stubs at the cash register (known in the industry as the point of sale).

"My guess is most people don't walk around with either a pay stub or financial information in their purse," Duncan says. "In an effort to achieve one goal, the Federal Reserve Board may be inadvertently issuing consumer unfriendly regulation."

Macy's and other stores claim the restrictions could impact consumer spending at a time when the country is trying to pull itself out of a recession. Retailers have other reasons for concern. Data compiled by The Nilson Report, a payment card industry newsletter, show store credit cards were declining long before the new credit law. Outstanding balances on retail store cards -- known in the industry as private label credit cards -- have been falling as a percentage of total credit card balances for nearly two decades -- from nearly 24 percent in the early 1990s to about 11 percent in 2008, according to Nilson.

Some shoppers are shunning store cards -- which typically limit customers to spending at a single store chain -- and opting instead for general purpose credit cards that carry the Visa or MasterCard logos and can be used anywhere those brands are accepted. Store cards have historically had higher default rates and cardholders with lower credit scores than general purpose cards.

My guess is that most people don't walk around with either a pay stub or financial information in their purse.

-- Mallory Duncan
National Retail Federation

How instant credit works
Currently, many stores require sales clerks to ask if shoppers have store credit cards. If they don't, the smiling clerk makes a pitch to sign customers up for cards -- sometimes with the inducement of getting 10 to 15 percent off that day's purchase, or, if online, getting free shipping or a gift card. If the customer agrees to get the card, they may be given an application form to fill out. Some stores have computer terminals set up to allow customers to input personal data: name, address, date of birth and Social Security number. In other stores, customers may be asked to fill out paper application forms, which are used by store personnel to input data into a computer.

With the click of a button, the application is electronically sent to the credit card bank used by the retailer or directly to a credit reporting agency (Experian, Equifax or TransUnion). Within seconds, a credit report and credit score is generated for the customer, and the bank sends an approval or denial of the application to the store. If approved, the customer's purchase goes through as the first charge on the new credit card account. The actual card is mailed a few days later, along with the credit card agreement outlining the terms and conditions of using the account. If there's a problem on the credit report, such as a history of paying bills late, bankruptcy, charge-offs or debt collection activity, the application is denied and the customer may be asked to provide additional information, such as bank account numbers or proof of income.

There's no huge benefit of instant credit for consumers.

-- Gail Hillebrand
Consumers Union

Under the Fed's new "ability-to-pay" rule, there could be an additional step that would take the instant out of instant credit. "A card issuer has not complied with this provision if, for example, a card issuer does not review any information about a consumer's income, assets, or current obligations, or issues a credit card to a consumer who does not have any income or assets," according to the Fed.

That could mean customers may have to hand in a pay stub or some other proof of income or assets along with the initial credit card application. Stores would have to figure out how to scan this information into their computer systems and how to evaluate the customer's ability to pay based on that documentation.

Liar loans?
Another potential problem: Customers who deliberately lie about their incomes, either because they are embarrassed to reveal it to store clerks, want privacy or want to overstate their income in hopes of improving their chances of getting a credit card. Currently, annual household income is a standard question on credit card applications. This amount is self-reported and not verified.

Duncan from the retail federation argues past credit history is a better predictor than income of how customers will repay credit card loans. Income becomes more important for big ticket items such as homes and cars, he says.

"An applicant's credit history demonstrates a consumer's commitment to meeting their financial obligations," Steven Franks, Macy's senior counsel wrote in the comments filed with the Fed. "Their ability to properly budget for monthly expenses is indicative of their ability to make at least their minimum payments. This type of evaluation is more revealing to a credit card lender than asking an applicant for an unverified income amount."

The proposed rules may also create new roadblocks for stores hoping to increase credit limits on existing accounts. Duncan gives the example of a customer with an $800 credit limit on a Saks credit card who wants to buy two suits that cost a total of $900. The store can run a credit check, look at the customer's past payment history with the store and instantly approve bumping the credit limit up to $1,000 to accommodate the sale. Under the proposed Fed rules, the clerk would have to ask the customer for income information.

"Most consumers would find that conversation, if not intrusive, then distasteful while standing in line," Duncan says.

He adds: "We're not in the position that we want to alienate good customers ... Very few merchants are going to want to have that conversation. You want to have as few negative conversations with your customers at the point of sale."


Some of the nation's top retailers filed comments with the Federal Reserve objecting to proposed rules on assessing applicants' ability to repay credit card debts.

Click the links to read their comments.

"We are worried that this new requirement will have a chilling effect on the willingness of our customers to apply for credit and the willingness of our store associates to offer credit."
-- Belk Inc.

"There is concern that consumers will
hesitate to provide such sensitive and personal documentation (like pay stubs) to retail associates."
-- Best Buy Inc.

"Consumers seeking credit should not be required to make information about their
income or assets public in order to apply for credit in a retail store."
-- Charming Shoppes Inc. (Lane Bryant, Catherines Plus, Petite Sophisticate, Fashion Bug)

"Consumer credit is crucial to our retail business and we do not wish to create unnecessary hurdles for our customers."
-- Lord & Taylor

"Both the store associate and the applicant are placed in an uncomfortable
position when discussing sensitive information with other customers standing in close proximity."
-- Macy's Inc. (Macy's and Bloomingdale's)

"Very few people carry income information (such as a pay stub) that would be necessary to satisfy the proposed language nor would customers (and those waiting in line behind them) be inclined to wait in line for it to be evaluated."
-- The Talbots Inc.

"We believe that the proposed rule will restrict commerce."
-- Saks Fifth Avenue

Consumer group: Instant credit fuels impulse buying
Consumer advocates and credit counselors who coach people out of mountains of debt say making it harder for people to get credit cards while shopping is a good thing. It may cut down the number of people who get into trouble with compulsive buying.

"The risk of instant credit is impulse borrowing," says Gail Hillebrand, financial services campaign manager for Consumers Union, the nonprofit owner of Consumer Reports Magazine. "Instant credit is generally not a good idea for consumers. Other people can get it pretending to be you, which creates a mess for you."

Hillebrand says consumers with decent credit scores likely have the ability to pay. "If can you afford to make the payment, you probably already have credit available to you. In that case, you can use another credit card. There's no huge benefit of instant credit for consumers. It's retailers that need instant credit -- not consumers."

Duncan from the retail federation acknowledged that retailers will lose out if instant credit is curtailed. "These customers are typically more loyal to the stores," Duncan says, adding, "There are advantages to both the retailers and the consumers in this."

Signing up for a store credit card is about more than just getting a credit card. The retailer builds a database of loyal customers that can be mined for years with marketing and promotional programs. Store cardholders who are offered special deals and services (earlybird specials, discounts, coupons, etc.) help move merchandise and contribute to a store's bottom line.

At Lord & Taylor, the high-end retail store, 40 percent of its $1.1 billion in customer sales is conducted with a Lord & Taylor credit card, according to comments filed by Christopher Sim, the company's senior vice president and CFO. Similarly, Belk, a department store chain that operates in 16 states, predicted a sales hit.

"The ability of customers to purchase on credit is critical to our retail sales," wrote James. A Ward, Belk's vice president of credit. "In these tough economic times, we simply cannot afford for credit to become less attractive or more cumbersome to obtain, and we expect this income requirement to have a direct impact on our sales."

As an alternative, several retailers have suggested that the Fed modify the rules so that opening credit card accounts with small credit limits -- perhaps $3,000 or less -- would be exempt from income review requirements.

Hillebrand from the consumer group agrees a low credit limit account may not warrant a review of income data. "They certainly could start you off with a very low credit limit," she says. "If you want more, fill out the form and tell us all this other information."

Credit bureaus offer solution
Experian and Equifax -- two of the three major credit reporting agencies (TransUnion is the third) -- have launched services in recent weeks they say will help retailers and other lenders assess borrowers' ability to pay in the same amount of time it currently takes to pull a credit report. Called income-estimation modeling, the programs rely on statistical analysis of databases of financial data to estimate a credit card applicant's income and assess their ability to pay loans.

Experian's Income Insight tool uses verified financial information from the IRS and other sources and links it to the credit bureau's database of millions of consumers, says Brannan Johnston, Experian's vice president of income and deposits. He says the model assesses the likelihood that applicants can pay based on verified income from the databases and on outstanding credit balances, available lines of credit, how long they have had credit, the sizes of their mortgages and whether they've ever missed a payment.

"For those lenders that ask income on an application, Income Insight can be used for income verification," Johnston says, noting that because the program is a statistical model, it is not used as the sole basis for declining an applicant. People who are deemed unable to make payments by virtue of the model would be asked to submit pay stubs or other proof of income before they could get loans.

Equifax announced on Dec. 8, 2009, it was expanding its ability-to-pay services to include tools that use IRS, employer and other databases to estimate personal income. "By combining the predictive power of modeled financial measures, such as income, with the accuracy of bureau data and verified income, credit issuers have additional options to minimize risk and assess consumer ability and willingness to pay," according to an Equifax statement.

Representatives from Experian met with Fed officials in November to brief them on how the income estimation tools may help lenders meet the ability to pay requirements.

The Fed is reviewing the comments submitted on the guidelines and must issue final rules before the Feb. 22 effective date of the credit card law. A Fed representative would not comment on whether the ability-to-pay rules will be revised based on the retailers' concerns or if the income estimation modeling tools would satisfy the Fed's requirement for assessing ability to pay credit card loans.

What will retailers do?
Duncan from the retail group says if the Fed doesn't revise its rules, some retailers may be forced to back away from instant credit offers.

"Some will try, in some of their stores, asking for financial information at point of sale," Duncan says. "If the reaction is negative, it will go away. In the short term, it will dry up a lot of very good deals for consumers."

Tough choice: credit card debt vs. down payment on a car loan

Consider your credit score, amount of debt and size of loan

By Todd Ossenfort

The Credit Guy
'The Credit Guy,' columnist Todd Ossenfort
The Credit Guy, Todd Ossenfort, is a credit expert and answers readers' questions about credit, counseling and debt issues.

Ask a question

'The Credit Guy' archives

Question for the CreditCards.com expert

Dear Credit Guy,
I have two credit cards. One balance is $2,645 with a credit limit of $2,800. The other balance is $5,143.86 with a credit limit of $5,500. I have $1,800 that I was going to pay on these or pay down on a car. My credit score is 680. I pay my bills on time all the time and always more than the minimum. I was looking to buy a car within the next 30-45 days. I am wondering whether I should pay this money on one or both of my credit cards, and how much? (Which will help my credit score the best?) After making these payments to my credit card or cards, how long does it take for your credit score change to show up? I really would like to get the best interest rate when I go to buy my car. -- Sharon

Answer for the CreditCards.com expert

Dear Sharon,
I believe you would be better off in the long run using your $1,800 as a down payment on your car purchase. My rationale is that if for some reason you needed to sell your car, particularly early on in your loan term (reasons you may need to sell might include getting laid off from your job, a decrease in salary or some other interruption in your income) without a down payment, it is likely you would be upside down in your car loan. Upside down means you owe more on your loan than the car is worth. In a must-sell situation, you would then be in a bad financial situation, either having to continue to pay on a car loan when you no longer own the car or face repossession because you can no longer afford the loan payments -- both of which could be very expensive.

With a credit score of 680, you would qualify for a national average 48-month term loan on a new vehicle at 9.5 percent interest. If you increased your credit score to the next level or 690-719 range, the national average for a 48-month loan would be 7.5 percent. The lower rate would save you $906.46 in interest charges on a $20,000 loan over the life of the loan. I know you don't want to pay any more for your car loan than you need to, but I would rather you plan for the unexpected.

If you disagree with my advice and would rather use the money to pay down your credit card balances, you could pay $1,245 on your card with the balance of $2,645 and the remaining $555 on the card with the $5,143 balance. Paying the majority of the $1,800 on the lower balance card will bring what you owe down to 50 percent of your credit limit and should boost your credit score. One of the elements considered for your FICO credit score is the ratio between the credit available to you and the credit you are currently using. The goal is to owe less than half of the credit available to you. You would still be over that limit on the higher balance card, but you would be bringing one of the accounts down to that magical 50 percent acceptable level.

Take care of your credit!