We've now covered three of the five categories that represent the points that you earn, which make up your credit score. We've explored Payment History, Your Amount of Debt and the Type of Accounts in Your Credit Reports. To quantify those three categories is very easy. Collectively they will make up 75% of the points in your credit scores. The "point" range (also known as the "scale") of the commonly used credit scores is 300 to 850 so that means that even if you earned the maximum number of points out of our previous categories your score will be no higher than 638 which is significantly below the national average. That makes these next two newsletters just as important as the first three.
This article will explore the fourth of the five categories: How Long Have You Had Credit? We'll also provide you with tips on how to earn the maximum number of points out of this category, which is worth a significant 15% of your overall credit score.
Before we get into the details of this category, the definition of "how long you have had credit" must be clearly understood. This category is the cause of one of the most prevalent credit scoring myths. It addresses the age of the information in your credit history, not your own age. Surveys have shown that an overwhelming percentage of consumers wrongly believe that your age can have an effect, either positive or negative, to your credit scores. Your age is not a component of credit scoring models. The reasons that your age doesn't matter might surprise you. Let's take a little quiz.
1. Because it is illegal to use age as a factor in credit scoring models.
2. Because of legal protections to various age groups.
3. Because of the negative PR that it would cause those who develop, sell and use credit scores.
If you guessed #1 then you are mistaken but don't feel bad about it. This is a common misunderstanding. The use of age as a part of credit or insurance decision-making is not illegal. Think about it, age has been openly used by the insurance industry for decades when they set your automobile policy premiums. You just can't use age as the sole reason to exclude someone from being approved for credit or insurance.
In this case the correct answers are both #2 and #3. Let's discuss the three options...
The Legality of Using Age as a Component - Contrary to popular belief, it is not illegal to use someone's age as a component of a credit-scoring model. As stated above, age is openly used as a decision-making component of insurance underwriting and has been for years. In fact, research has proven that someone's age can be a very powerful predictor of someone's future credit performance.
Credit score developers have gotten around this by identifying and using "proxy" characteristics. These are characteristics within the credit scoring models that are similar to "age" but aren't exactly age. We'll dig further into this practice later in the newsletter.
Legal Protections - Arguably the group that stands to lose the most by having their age considered in the scoring models is the elderly. Older Americans, theoretically, are on more fixed incomes and can't afford the payment amount uncertainties that are common with variable rate loans and the ever-changing minimum payments on credit cards. As such, the credit score developers were stranded between the proverbial "rock and a hard place." How were they to take advantage of this powerful characteristic but not treat elderly people unfairly, which would be illegal? The answer is quite simple. You would chose to compromise the predictive value of the model by simply ignoring what the research says about a risky age group by giving them the maximum number of credit score 'points' from this category.
This, of course, is the wrong thing to do. From a statistical perspective you are degrading the value of your credit-scoring model by giving away points and going against what's "predictive." This is exactly the opposite of what research proves. As such, it's easier to make the decision to ignore the consumer's age and hope you can make up for it with other credit score model characteristics.
Public Relations - Credit reporting and credit scoring has always been a favorite target of consumer advocates, minority protection groups and class action lawyers for a real or perceived lack of fairness and consumer access. In fact, in the very recent past the Fair Credit Reporting Act, which governs credit reporting and its use by creditors, has been aggressively amended with the Fair and Accurate Credit Transactions Act of 2003 (also known as FACTA or The FACT Act) to allow for consumers to receive free copies of their credit reports once a year.
The last thing that creditors, credit reporting agencies or credit score developers want or need is yet another controversial decision such as weighing a person's age in their scores. As such, public relation concerns are one of the two reasons why age is not considered in the scoring models.
So the bottom line is this: your age has no impact, positive or negative, on your credit scores.
What it means is the age of your credit report. Yes, your credit report has an age just like anything else. And that age has a positive or negative value in your credit scores. This value equates to 15% of the points that make up your overall credit scores. The question now becomes how the credit scoring models determine the age of your credit file and how the age impacts your score. Let's investigate the various ways this occurs.
The age of your oldest account - Each of the accounts on your credit report has a field called "Date Opened." This date has been reported to the credit reporting agencies by your creditors. The date opened is supposed to be exactly what it sounds like - the month and year that the account was opened.
The credit scoring models can read this date and "age" the account by calculating the number of months and years that the account has been open. Once this is done on all of the accounts the models will then determine which one is the oldest. This oldest date becomes the age of your credit report. Assuming that today's date is May 15, 2005, the credit account shown below will read an age of 5 years. Now assume that this is the oldest account on your report and this will now become the age of your credit report - 5 years old.
|Subscriber||Account Number||Account Type||Date Opened||Loan Type||Current Status|
|Discover Card||30492383XXXX||Revolving||May, 2000||Credit Card, Terms REV||R1|
The average age of your accounts - Another important measurement is the average age of your accounts. This is simply the average age of all of your accounts as measured using, again, the date opened fields. For example, if you have 2 accounts that are 3 years old and 5 years old respectively your "average age of credit" will be 4 years.
Since credit information is constantly being added to and removed from your credit reports a logical question would be to ask what happens to these two categories when items fall off and get added to your reports. The answer is that accounts falling off and being added to your credit report will cause your average to change constantly. Sometimes this can have negative consequences.
When information is removed from your credit reports it essentially disappears and cannot be used in any sort of credit scoring measurements. As such, old accounts that fall off of your credit reports can never help your average again.
You bet they can and they do. Don't be fooled into thinking that creditors, credit reporting agencies and credit score developers are simply overlooking this potentially valuable measurement without a Plan B, which is the use of "proxy" characteristics. A proxy characteristic is a way of measuring sensitive information, like your age, in an indirect and less offensive manner. Let's look at some ways of measuring personal and sensitive qualities in an indirect manner.
Overweight or not? - It would be unreasonable to think that asking someone straight out "how much do you weigh" wouldn't be offensive. But if you wanted to know how much someone weighed then you could ask him or her where they shop for clothes or how often they exercise or even how much they enjoy fast food restaurants. Knowing the answers to these questions and a few others could give you a reasonable picture of whether or not someone is overweight. It's not a guarantee but it certainly gives you something to think about.
Do you smoke? - This is another very sensitive subject. Coming right out and asking if someone smokes might lead to a response like "it's none of your business." But, if you asked someone if they agree with smoking restrictions in airports and government buildings you might be able to use their answer and make a more educated assumption about whether or not they smoke. Or, better yet, they might even volunteer the answer. You've accomplished your investigative goal without really asking the most direct question and offending someone.
Political Affiliation - This might be even more sensitive than the smoking example. It's not something that you would ask in a professional setting to be sure. But, if you asked someone what they thought about the television coverage of the Republican or Democratic National Conventions the answer might shed some light on their preference.
This is exactly how credit scoring models measure your age, in an indirect manner so not to offend anyone. The average age of credit account and the oldest account measurements are their way of indirectly measuring your age without really asking how old you are.
As with any component of a credit scoring model, the developer's research has determined that these age measurements are valuable enough to make it into their models. In fact, these measurements have made it into the models for decades and it doesn't look like they are losing any value so expect them to be around for a while.
In this case the use of age makes statistical sense as well as common sense. Consumers with a younger credit history tend to be more risky borrowers than consumers who have had credit for many years. Put yourself in the position of being a lender. If someone came to you and asked you to borrow $10,000 wouldn't you want to know if they've ever borrowed any money in the past? Or, is this their first time? Are you comfortable being their first lender? How about if they wanted to borrow $250,000 from you to buy a house but they show no history of borrowing money, especially that amount. Are you willing to take that chance? As you can see, it's not really unreasonable to take age into account when making these decisions. It's not a popular choice but it's certainly hard to argue that it's not a good idea.
You want your credit accounts to be as old as possible. Here's why:
Credit scores are a standard component used in today's lending environment. Each of us has three different credit scores, one generated from each of our three credit reports. It's important to become familiar with the impact the age of your accounts has on your credit scores.
The goal for this category is very simple. You want your credit reports to be as old as possible. You also want the average age of your accounts to be old as possible. The older these measurements, the more stable your credit reports will become. And in this case, with stability comes more points for your credit score.
There really isn't a target age that you should strive to achieve. At some point you will max out on the points for this category and aging your credit files any longer really won't help. While the optimal ages are a closely guarded trade secret, it's safe to say that you will have to have had credit for many years before you will earn the maximum points in this category. The good news is that now that you know how important these age measurements are, the better credit shopping decisions you can make.
1. Get started and be patient - We all started in the same spot, with no credit and no credit report. If you are a young consumer or have chosen not to ever use credit then it's time to get started. Applying for an easy-to-get account like a retail store card or a secured credit card will establish a credit report in your name. Now it's time to be patient as that account ages. As you add new accounts to the credit report you will hurt your average age of account (remember that the credit scoring models also average the age of your accounts) but eventually the numbers will work in your favor. If you have many accounts that are very old you won't be able to lower your average any longer. You've arrived.
2. Do NOT ever try and get old accounts removed - For some reason a very common myth floating around is that you should have old or closed accounts removed from your credit reports. Why would you ever want your history and positive payment removed from your records? What if you got excellent grades in high school and college 20 years ago? Why would you ever fight to have that record removed? You wouldn't. Don't be fooled into thinking that old accounts hurt your credit scores. They do nothing but help them.
Exception - As with all rules there are exceptions. In this case it's more of an "FYI" than an exception. You may be wondering whether to remove old accounts that are negative? Isn't it better to have those accounts removed?
The answer is "don't worry about it." Negative items will automatically be removed after their statute of limitations expires. You will not have to ask that they be removed. It is done by the credit bureaus as a standard practice.
3. Be aware that opening accounts will lower your average age - The advice here isn't to not open new credit accounts. Everyone has to open credit card accounts, buy cars and houses and finance other things. You should be aware, however, that each time a new account hits your credit file the age of that account will become part of the averaging process. And since the account is brand new it will lower the average age of your accounts. So, be selective when you are shopping for credit. Don't open up multiple retail store credit cards around the holiday season just to save 10% off your purchase. The negative impact to your scores will cost you much more in the long run.
Next we'll present the final issue in our series of newsletters about the categories that have the most effect on your credit scores - Your History of Searching for Credit and what you can do to ensure maximum points from this category, a category worth the final 10% of your credit score points.