Credit-Score Pitfalls of the Wealthy

By: JILIAN MINCER | Wall Street Journal

Even the rich need to worry about credit scores.

The economic crisis has put a premium on these numbers which, when too low, can limit access to loans, insurance, even employment. But many affluent investors unknowingly hurt themselves with late payments, credit-card debt and not borrowing enough despite, or perhaps because of, high incomes.

Truth be told, being wealthy doesn't always make people smarter about credit. And contrary to what some people think, income and savings aren't factors in determining a credit score.

"Regardless of their finances, age, gender or ethnicity, people don't have an understanding of how credit works," says Jeremy E. Portnoff, a financial adviser with offices in Union, N.J., and Tustin, Calif. "They should be aware of their scores, especially in this environment."

He recalls a client who, despite more than $1 million in assets, had a poor credit score because he avoided any kind of borrowing -- he rented his home and didn't use credit cards. Because of that, he would have had difficulty getting a mortgage -- something he plans to do when he retires.

"He grew up thinking credit was bad," says Mr. Portnoff.

The credit crisis has raised the bar for people of all economic classes. Everyone needs higher scores now to qualify for loans and keep the cost of borrowing down.

"We think the limit is at least 760 to qualify for the best rates," says Scott A. Beaudin, a financial adviser with offices in Burlington, Vt., and Atlanta, Ga., who likes his clients to always be "credit ready."

"People don't know how to build credit, and they don't know how to keep it," he says.

And ignorance isn't bliss when applying for a mortgage or buying insurance.

Mr. Beaudin says one client, who plans this year to buy some property, was shocked to learn his credit score was only 740 despite a $1 million income. Fortunately, the number shot up by 60 points after incorrect information about a family member was removed from his credit report.

Scores typically range from 300 points to 850 points, and most people don't know theirs until they seek a loan. Corp. developed what is considered the "traditional" credit score, which is used by more than 90% of the largest lenders.

It recently tweaked the scoring model so it is "more sensitive to high usage (of credit)," says Craig Watts, a spokesman for Fair Isaac. At the same time, the impact of a single late payment was reduced, he said.

Historically, about 40% of the population had a FICO score of 750 or higher, 27% had scores of between 600 and 699, and 15% had a score below 600.

While some people have seen their scores drop in recent months because of foreclosures and bankruptcies, "other people have risen in response to their more careful and conservative management of credit," Mr. Watts says.

Scores vary somewhat among Fair Isaac and the three largest credit bureaus -- Inc., Experian and TransUnion -- although all embrace similar formulas.

Typically, about 35% of the score comes from a person's payment history. Paying on time helps raise the score, while late payments, liens and bankruptcies will reduce it.

Another 30% is based on the amount someone owes -- the less the better. Another 15% comes from the length of a person's credit history. The older the accounts, the better. The remaining 10% is based on the type and variety of credit. Having credit cards, an installment loan and a mortgage is better for your score than having only credit cards.

Getting the best rates could save thousands of dollars a year. Raising a score from a range of 640-659 to at least 760 could save someone with a 30-year, $500,000 fixed mortgage an average of $344 a month, according to Fair Isaac's Web site

But it's not just mortgages. Prospective employers and insurance companies also use the number. And that could hit unsuspecting affluent investors.

They could pay more than they need to if their scores "drift downward because of a lack of use of credit," says Mr. Beaudin.

Start by requesting a copy of your credit report. They are available free once a year from each of the three major credit reporting agencies and for a fee more often. However, consumers must use the Web site rather than the individual Web sites to get the free reports. Beware of impostor sites.

Check the reports for errors, omissions and potential identity theft. Omissions matter because you want to show that you have paid off loans.

Some strategies are obvious, others are counterintuitive. For example, paying your bills on time is crucial. So is paying off credit-card debt.

If you don't pay off your card debt every month, pay it down to less than half the maximum available balance.

Don't consolidate debt on another card unless the interest rate is significantly lower and you plan to pay it off within the year, says Mr. Beaudin.

Another surprise -- don't cancel the bank card once you've paid it off because the score considers longevity and available credit.

A common mistake for affluent individuals is never using a credit card. Advisers recommend that they use it even just once a year and pay it off immediately.

A score can be hurt if multiple lenders request a person's credit report because they're shopping for a mortgage or auto loan. To avoid this, Mr. Beaudin suggests, get "good faith" estimates from banks without giving your Social Security number.

If you plan to apply for credit in the near future, don't use credit cards for groceries and other payments. Credit rating companies only see the balance on the day they check. They don't necessarily know if you pay it off each month.