|Gary Foreman is a former Certified Financial Planner (CFP) who currently writes
about family finances and edits
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purchased a 1999 Buick Regal right before Thanksgiving. The loan was
for a 14.5% interest rate. I was told that I should wait at least
one year before refinancing. If I did otherwise it would look bad in
my credit for not staying with this company for at least a year. I
am interested in shopping around to see if I can get a lower
interest rate, but am uncertain due to the information that was
given. Should I shop around or wait until a year has been
Like many of us, Lillian is concerned
with her credit score. And, she should be. Not only will her credit
score affect how much she'll pay to borrow money, in some cases it
can make getting credit difficult or impossible.
Before we look at Lillian's question,
we need to learn a little more about credit scores. The largest
supplier of credit scores is Fair, Isaac & Co (FICO). The score
is designed to give potential lenders an idea of how likely you are
to repay a loan. FICO has demonstrated that a lower score does
correlate to a greater probability of default.
FICO scores range from 400 to 900.
About 700 is considered average. The exact formula used is a FICO
secret. But they do provide an idea of what things go into the
formula and how much weight each category is given. That should be
enough to help Lillian with her question.
The advice given to Lillian is true,
but probably not as important as she was led to believe. The
longevity of her accounts only makes up 15% of her credit score. And
that's for all of Lillian's accounts.
The score will include the oldest
account she has and also the average of all accounts. So closing one
account early by refinancing really shouldn't make a big difference
in her score. Her average will dip slightly, but unless her score is
620 or below that shouldn't pose a problem.
The biggest determinant of Lillian's
score concerns how good she's been about paying her bills on time.
35% of her score reflects her promptness in bill paying.
The amount that Lillian owes will
determine 30% of her credit score. Naturally potential lenders feel
more comfortable if she owes less money. Accounts that are close to
their limit will lower her score.
Ten percent of the rating is based on
Lillian's pattern of credit use. The 'pattern' considers how many of
her accounts are fairly new and how many potential creditors have
asked for her history. People with debt problems often try the same
tactics. The FICO formula attempts to identify those people.
The final ten percent evaluates the
types of credit that Lillian is using. The types of accounts, mix of
accounts and total number of accounts she has are included. Loans
with finance companies will reduce her score.
More than one company provides credit
scores to potential lenders. Your score will not be the same with
each provider. We've used the formula from FICO for this discussion.
Other formulas are similar.
Now back to Lillian's question. She
didn't mention who told her to wait. It is possible that the person
who gave that advice stood to make more money if she delayed.
So what should Lillian do? The first
thing is to get a copy of her credit score. Next she should check
and make sure that the information is accurate. Studies indicate
that about one in four reports contain serious errors. Those errors
could reduce Lillian's credit score and increase the amount she'll
pay to borrow money. She can obtain her score at www.myfico.com.
Unless her score is below 620, she
shouldn't have to worry about refinancing now. A healthy credit
score won't drop much for one account. And any drop wouldn't affect
this refinancing. If Lillian manages her credit properly it won't be
important the next time she goes to borrow money either.
Once she's verified that the
information is accurate, she should begin to look for lower cost
financing. Identify two or three potential lenders. She'll want to
contact them one right after the other. Each lender will obtain her
credit score. If all those requests happen over a few days they'll
be treated as one event. If they trickle in over months, they'll
tend to decrease her score.
It is possible that she won't find
cheaper financing. But the only way she'll know that is if she
checks some competing lenders.