By Barry Paperno
Dear Speaking of Credit,
We have a financial planner person and a 401k person that we are meeting with. They are not credit people, though, so we needed input like yours as well.
My husband and I have just had our Chapter 13 discharged. We both have student loans that stem from additional college later in life. Mine is about $14000 and my husband’s $40000. We can pay off mine with 401k monies and avoid the 6.8% interest that’s been accruing in favor of a lower interest rate on a 401k loan.
- Is it better for rebuilding our credit to pay off the one loan or should we make payments, basically for the rest of our lives? I’m 48 and he’s 47. We have no other debt.
- What is this business about FICO score and how important it is vs. the credit bureau scores? Is FICO just the culmination of all three credit bureau ratings?
- We also have been receiving sales materials telling us that we have to take action (i.e. take a loan with us) now that the bankruptcy is discharged to get back on the credit bureaus’ radar again and get our scores going up or our scores will stay in the tanker (even though the BK has been discharged). What is that about?
Thank you — Mickey
Seeing as how you’re talking about tapping into retirement funds to rebuild credit, I’m really glad to hear you’re working with a financial planner and someone familiar with 401k’s. Otherwise, I would not want to even begin recommending or discouraging any particular credit-rebuilding action, no matter how good for your credit, that touches retirement funds. My answers to your 3 questions follow:
1. Having said that, and with good news for your 401k funds, it’s better for your credit score to keep a student, auto or mortgage loan “alive” for as long as possible by simply making the regular payments on time each month. Unfortunately, doing so means you’ll be paying a lot of interest along the way.
But, unlike high credit card debt, which can be one of the major obstacles in the way of a good score, the amount of installment debt you carry has very little impact on a credit score. That you pay it on time every month, yes. How much you owe, no. In fact, having at least one open installment loan – student, auto, mortgage – is usually better for your score than not having at least one open loan with a good payment history.
2. Without even the slightest exaggeration, and while not wanting to sound like an advertisement for FICO, know that your FICO score is the score that’s going to drive your real-life credit decisions, rendering the non-FICO credit bureau scores essentially meaningless for any practical purposes.
The FICO point range (300-850) is the same at all three credit bureaus, making comparisons easy, but that’s where the sameness ends. From bureau to bureau, the FICO scoring formula itself and the credit information being scored tend to be similar (+/- 20 points being typical), but rarely the same.
Your FICO scores obtained within the same time frame should also be similar, but again, not the same, at each bureau. If not even close, there are probably some major differences on 1 or 2, but not all 3, of your reports, such as different credit card balances or payment histories across the three credit files.
Each bureau’s FICO score tends to be considered separately by a creditor. FICO scores we see as consumers are never calculated using a combination of credit bureau reports. The best place to get your FICO score is myFICO.com. The best place to get your complete credit reports without a score is http://www.annualcreditreport.com.
3. While there is some truth to what those sales materials are saying, be very careful not to fall for their marketing shtick. You can, in fact, accelerate the recovery of your scores by establishing some positive credit history via secured and authorized user cards to effectively offset the negative history associated with the BK. If you don’t, your score will still rise (slowly) on its own simply via the passage of time, as the BK-related credit info falls further into the past.
This is another good scoring reason to keep the student loans open, as they will help move this process of re-establishing credit along. Additionally, obtaining secured credit cards in each of your names can help, particularly since the score doesn’t differentiate between secured and unsecured cards in its calculations.
Then by simply making a few small charges and paying in full each month you’ll be helping to raise your score faster. There are many such secured cards available and I don’t have any direct experience, but I hear Capital One has a good card that has no annual fee and converts to unsecured after a year or so.
Hope this helps!