June 30th is typically the busiest home closing day of the year. For most home buyers, it is also that time of the year where a credit score is thought of since the difference between a good or bad credit score could mean hundreds or thousands more dollars a year in mortgage payments. As the banks are slowing putting liquidity back into the market, many people are also considering applying for new credit or extending credit regardless of whether they are purchasing a home or not. Thus, a lot of people may be turning their minds to their credit score and how to improve it.

A credit score (or a FICO score) is a number between 0-800. The higher the number, the lower your risk to lenders and, ergo, the better your credit terms. Conventionally, any score over 750 will typically allow you to obtain the best credit terms. FICO estimates that 40% of the population has a credit score of 750 or greater (here is FICO’s primer on how credit scores work).

If you need to raise your credit score, the tired and true is to pay on time all of your accounts with your oldest accounts being kept in the best shape. But, if you are looking for some alternatives to raise your credit score, consider theses:

PREAUTHORIZE ONE PURCHASE ON AN OLD CREDIT CARD. Most of us have very old credit cards that we may not use because the rewards program is not great, the credit too small etc. Instead of canceling the old credit card-which impacts negatively on your credit score- pre-authorize one small transaction on it a month (newspaper subscription, membership fees, phone bill) and pay the entire amount off immediately. Do not run any other transactions on that card.

Why does this work? Several reasons: (i) you maintain positive payment history (payment history determines 35% of your creidt score); (ii) you keep your credit utilization low (balance owing is 30% of your credit score) and (iii) maintain activity on an aged account (15% of your credit score).

MAINTAIN A LINE OF CREDIT BACKED BY CASH COLLATERAL. This one was told to me by a banker and especially useful if you have emerged from bankruptcy or have bad credit history. The key is you have to earn someone’s trust. Open up a line of credit (“LOC”) which is backed dollar for dollar in cash collateral held in a GIC or money market fund at the same bank you obtained the LOC; this will help someone with bad credit obtain a LOC since the bank has de facto secured interest for an unsecured credit line it usually only gives to people with good credit scores.

The money for the collateral is put up by someone you trust (the “guarantor”). Arrange for the line of credit to be withdrawal only if both the borrower and the guarantor sign for it (your bank can arrange this). Then, you make a deal with the guarantor: every quarter you draw down on the LOC in a very minimal amount only IF you have the cash to pay it back immediately (perhaps you give the cash to the guarantor first).

Why does this work? You are taking the following positive steps: (i) establishing payment history; (ii) establishing a a type of credit in use properly (10% of your credit score); (iii) maintaining low credit utilization.

Thus, rather than do a straight guarantor arrangement (which can work), you have put in mechanics (duel signing authority) to control the use of the LOC which should give your guarantor a measure of security (assuming your guarantor has the discipline to say no to you). It is actually a practical manner to build a credit score of someone who has been undisciplined in their spending in the past.

BUILD BACK UP GOOD HISTORY ON A BAD AGED ACCOUNT. Many borrowers, after they have had a bad history with a credit account, stop using it and open up a new account. This is generally a bad idea. A new lender will look up your credit score (which decreases your score) and the credit score system favors aged accounts over new ones. The better thing to do is to begin to make regular payments on all your old accounts.

Why does this work? Re-establishing payment history and reducing amounts owing are the two largest factors in determining a credit score. Open new accounts quickly and having multiple inquiries into your credit score account for 10% of your credit score but it is often used negatively.

Its easy to destroy your credit score. Harder to maintain it. The key is to be regular in payment and be disciplined in how you use your credit. Good luck.

Anyone else want to share any alternate tips?

Canada’s Department of Finance issued proposed new regulations on credit card rules which are aimed towards: (i) targeting certain abuses of the credit card industry; and (ii) providing better transparency for all credit card users. Since the regulations are subject to consultation, they are not final but here are a few proposed changes to be aware of:

1. There must be a 21 day grace period on new credit purchases. Currently, some credit card issuers accrue interest on new purchases if the customer has an outstanding balance carried forward in the previous statement. In other words, interest is charged on both the outstanding balance and the new purchase. The new regulations require credit card issuers not to charge interest for 21 days on the new purchase.
2. Allocation of payment will be beneficial to the customer. Some credit card charge different interest rates for purchases, balance transfer credit cards and cash advances with the credit card company being allowed to apply payments to the balance with the lowest interest rate. The new regulations would require credit card companies to allocate payment to the balance charging the highest interest rate or proportionally to different balances, with both methods resulting in lower interest being paid by the customer.
3. No credit limit increases without consent.
4. No penalties if credit limit is exceeded due to merchant holds. Some merchants place holds on credit cards until the transaction is completed (for example, if you book a hotel room, the hotel will hold place a hold on your credit card to ensure they are paid). If a customer’s credit limit is exceeded due solely to a merchant hold, the new regulations prohibit the credit card companies from penalizing the customer for exceeding its credit limit.

For most card card holders who do not use most of the credit provided or pay their balance in full every month, these proposed measures will have little to no impact on their everyday lives.

However, as part of a separate set of regulations, new disclosure rules are also coming into force:

1. Key information must now be in a summary box. The current regulations do not require interest rate information, grace period terms and other fees to be consolidated in one place. The proposed regulation requires all future credit card statements to consolidate the information in one summary box.
2. Disclosure as to consequences of only making minimum payment must now be provided.
3. Notice must now be provided in advance of interest rate increases.

While these are all positive moves, the cynic in me wonders about the law of unintended consequences. By requiring the credit card companies to add new layers of bureaucracy, its cost of business has just increased which means that one or all of the following may happen:

1. Increased annual fees;
2. Slashed credit card reward benefits (a move which is already occurring in reaction to the American version of new credit card regulations); and
3. Higher interest rates.

In other words, there may be an indirect tax to all customers which only further weakens those who cannot handle credit properly and punishes those who can.

Fundamentally, someone will always find a way to get around a law or regulation if they want to and no law is perfect. The larger question is what are governments doing to encourage education and awareness of personal financial responsibility on the consumer level? The relative silence on this matter is deafening.

If you are visiting my blog through the Canadian Tour of Personal Financial Blogs hosted by Money Diva thanks for visiting. This the second in a two part series about improving your credit score, the first part was posted an hour ago which discussed the basics of how your credit score is arrived at. This post builds upon the basics by providing several suggestions on increasing your credit score based on the basics. Enjoy.

Some mortgage brokers tell me that improving your credit score is part art and part science. The following are some steps I have learned in increasing your credit score:

1. Pay every account on time- This sound really simple but there is real beauty in simplicity. If you cannot make payments, make sure you are never 60 days past due. Some creditors will not report you if you are under 30 days past due but they will definitely report you for 60 days over-due.

2. Activity counts on each and every account- A lot of people have credit cards that they never use. I am advised that this actually hurts your credit score since your file isn’t “active” on particular accounts. Activity generally means that you are using a particular account every 3 months or so. I find the best way of keeping all my accounts active is to spread out my pre-authorized payments among several credit cards. For example, I have one credit card from my university days which I do not use since the rewards are non-existent; however, I set up a monthly pre-authorized payment on it for a small amount (my newspaper bill) and pay it off on time to keep a good and active credit history on this card (because the amount is so small, I am not losing a lot of points by not running it through my point lucrative credit card). The pre-authorized payment route saves me time in trying to figure out when to use which card when. I also draw down on my line of credit every so often, even if I don’t need the money, and pay off the principal the next day to keep a good history on my line of credit.

3. If you have to, cancel the newest credit instrument first: Remember that credit history and debt to credit ratios count. If you cancel a long standing account (assuming its in relative good shape) you are erasing credit history and increasing your total debt to credit ratio since the available amount of credit to you just decreased pushing your ratio up. This is why I will not cancel my credit card I received when I was a freshman in undergrad.

4. Divide the cost of large purchases among several accounts: If you buy a dishwasher and max out one credit card to do it, your debt to credit ratio increased to 100% on that account which decreases your credit score. Split the purchase of big ticket items between several credit cards and try to keep the debt to credit ratio on each card under 50% (i.e. only use 50% of the credit available under each card).

5. Do not apply for a lot of credit at once: This is a particularly important tip for students who have just graduated or recent immigrants without a domestic credit history (why a credit score cannot be transferred internationally is beyond me). If you do need credit, try to consolidate it with one institution which only has to run your credit score one. For example, apply for a credit card and a line of credit at one bank or at the same institution that is administrating your student loan; it will only require one credit check and, if you subsequently apply for more credit at that same institution, at least they will know that all the new accounts are with them.

If anyone is thinking of applying for a mortgage, start creating a good credit history on each account. You should ideally keep several accounts in good standing (and with a low debt to credit ratio) for at least 6 to 12 months minimal. It will increase your score and save you money.

There’s one last point I want to address- consolidate your accounts with one bank. Banks have their own internal credit adjudication system which generally does not rely on checking your credit score. They will offer you credit to keep you as a customer. For example, I received an unsecured personal line of credit at the maximum allowable limit with the lowest interest rate without even asking for it because all my business and personal accounts are kept at the same bank (the fact I have never bounced a cheque and have a 15 year history with them also helps). Bank will literally buy your loyalty with credit. As long as you know how to use it properly, you can increase your credit score.

Good luck increasing those credit scores.

Is your financial fate determined by a three digit number? In some senses, it is. A credit score (also known as a FICO or Beacon score) is a three digit number which all lenders will refer to before lending you money. Improving your credit score can result in sufficient cost savings over time. For example, according to FICO, if you improve your credit score from 660 to 760, the interest rates on a $216,000 30-year fixed mortgage drops from 6.5% to 5.89%.

However, keep in mind that all financial institutions use their own internal credit adjudication systems, in addition to your credit score, to determine whether to loan you money and at what rate. So a credit score given by a credit bureau is not the end all and be all. Regardless, given that a good credit score can literally save you thousands of dollars a year, it is within everyone’s interest to improve their score.

Since I started my own business, I have been extremely interested in finding ways to improve my credit score. Even if you run your own business, banks continue to lend money to small businesses based on the owner-manger’s credit history and not the business’. So being late on those student loans 5 years ago can come back to haunt you. It is not exactly fair but that’s how the game is played.

As the above shows though everyone has an interest in improving their credit score. I have attempted to summarize what I have learned (obviously, please don’t take this as gospel on the subject; I have tried to edit this down for brevity). A lot of this is common sense but aren’t all things about money?

Equifax and TransUnion are two large bureaus which collect your score. A credit score is a number between 300 and 900; the higher your number the better. A mortgage broker once told me that the highest credit score he has ever seen in 830. However, as the FICO link shows above, there are only marginal benefits once your score is in the 760’s and higher (my score is 799 as of last November). The reports can be obtained for free by law in Canada (although it takes a long time to get one for free).

I run a report once a year. The first thing I do is to make sure everything is correct. If there are any mistakes, I have to contact the lender first and not the credit bureau. It is not uncommon for people with common names to have wrong entries which belong to other people with similar names- so if your name is John Smith or Stephanie Johnson, you better check your credit score carefully.

Improving your credit score is a bit of a mystery in that there is no publicly disclosed formula that I have seen which says if you do “x” your score will increase by a set number. However, credit scores look at the following factors (as a side note, the score is determined by looking at each account- credit card, line of credit, student loan- you have open):

1. Payment History- the less late payments the better. In other words, ALWAYS PAY ON TIME. This is the single most important factor in increasing your credit score.

2. Debt to Credit Ratio- A debt to credit ratio is calculated by debt/available credit for each account you have open. For example, your credit card has a $2,000 credit limit; if you use $500 of it, your debt to credit ratio is 25%. The general rule is to have a ratio of less than 50% on each account. If your debt to credit ratio is high, your score will decrease (try to keep it under 35%). A large part of my score is attributed to the fact I have 5 credit cards but my debt to credit ratio on those cards collectively is 2%. This is generally the second most important factor in increasing your credit score.

3. Credit History- The longer your history with a creditor (assuming it’s a good history), the better your credit score.

4. What Type of Credit Account do you have Open?- The system discriminates against you if you have only one type of account open (for example, all credit cards). This factor tends to decline if you have a long credit history but for those who are just out of school, this is an important factor.

5. How Many New Accounts Do You Have?- The more accounts you open in a short period of time, the lower your credit score.

To keep this post relatively short, I have separated out part 2 of this post which I’ll post in an hour. Thanks.