Sunday, October 28, 2012

Why Did My Credit Score Drop?

I have been doing very well with my budget.  My bills are being paid on time with a little extra.  Our debt is gradually dropping.  I checked my credit score, and I was shocked by what I saw... My credit score DROPPED!

Immediately, I began searching for any bills that I had not paid.  I couldn't figure it out.  Why did my credit score drop?  I found nothing!  I felt like crying.  All that hard work for absolutely nothing positive!  Travis had no idea what happened.  Let's just say, I freaked out.  I began thinking that nothing good is going to happen for us.  I began thinking that we'll never own a home.  I began thinking what's the point in even trying to pay off my debt - it won't help me anyways.

A few friends of mine know a lot about credit scores, mortgages, loans, and business-y stuff.  One night, while we were all hanging out having a few drinks, I brought it up to them.  I asked them, "How do people do it anymore?  Why is it my credit score drops when I do everything right?"  They started asking me a few really smart questions that I would have never thought of.

The greatest debt I have is student loans.  The credit cards are really nothing.  When I confessed to my friends how much I owe each month to student loans, it was roughly 60% of our net income.  Yup, that's right.  We pay 60% of our take home pay to student loans.  Because our credit card debt is so low, it's actually not a negative thing since we pay it off each month with a little bit of roll-over.

Your credit score is actually affected by your income to debt ratio.  I did not know that!  While we sat here thinking that if we paid off my student loans within 10 years, it would be better for us and that my credit score would improve.  Nope, it sure doesn't.  Your debt needs to be AT THE MOST 40% of your net income.  To qualify for better interest rates, your debt needs to be about 30% of your net income.  If your debt is over 40% of your net income, it reflects negatively on your credit score.  So even though we are paying off my student loans at the lowest current rates they offer for a 10-year repayment plan and paying off the principle, it doesn't increase my credit score.  Sure, we'd be saving more money in the long run... but it isn't helping us now get our footing in the real world.

If I increase my repayment plan to 20 or 30 years, it will boost my credit score and give us lower monthly payments.  It could possibly boost my credit score enough to qualify for a mortgage.  I brought up consolidating my loans... is that a good thing or a bad thing?  In my situation, it would be bad.

Because I am pretty well organized with my student loans, consolidating would not do me any justice.  It would negatively affect my credit score.  I have a variety of different student loans - some at low interest rates and some at high interest rates.  Consolidating would give me a higher interest rate than majority of my student loans.  The best decision for me is to keep them separate, pay the minimum balance, and then use what I have left to pay off the principle on my highest interest rate loans.  Consolidating would cause me to pay about the same or significantly more than if I just keep them separate and first pay off the higher interest rates in comparison to the principle balance for each.

So there you have it.  To help your credit score and prevent it from dropping, you must keep your debt at or below 40% of your net income.  If that means pushing my student loans off to a 20 or 30 year plan, then so be it.  It will definitely benefit us more than paying off the student loans right away.  After all, we still have our 10 year plan to paying them off - it just shows on paper that we plan to have it paid off in 20-30 years, showing that we are more financially responsible and trustworthy with our credit.

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