Q&A with a CPA: Credit Scores
As a volunteer member of the National CPA Financial Literacy Commission, I am closely involved with Feed the Pig, including participating in monthly Facebook chats to answer money questions. The most recent chat about credit scores generated quite a few great questions and reminded me just how confusing the whole credit score universe can be for non-financial people.
You can view a replay of the entire chat on Facebook here. Otherwise, a few highlights:
Q: How does co-signing your children’s student loans affect your credit score?
KCL, CPA: Co-signing for any loan is basically the same as signing for it as your own, so as long as the loan payments are current, it shouldn’t have a dramatically detrimental effect on your score. However, if your child pays late or defaults, it becomes your responsibility and that will show up as a negative thing. And it does contribute to the total amount of debt on your credit report, so if you have a lot of personal debt as well, it could inhibit your ability to take out any additional loans until your current debts are paid.
Real-life example: A family member recently obtained her credit score and it was just a few points lower than her husband’s, even though they pretty much share all the same credit history. The reason hers was a few points lower is because she also co-signed on her child’s auto loan. Her score was still above average, but it did have a small effect.
Q: Does the amount of a payment or the type of payment (house/car/credit card) affect a credit score?
KCL, CPA: There is such a thing as “good debt” and “bad debt.” A mortgage, car loan or student loan would fall in the category of “good debt” because the life of the thing you’re paying for (house, car, or education) exceeds the period of the loan. “Bad debt” is mostly credit card debt.
The amount of the payment doesn’t affect your score but the total amount of outstanding debt does, especially with credit cards. The closer you are to your credit card limit, the more negatively your score is impacted.
Q: What would you say is a good debt ratio to have a positive impact on your credit score?
KCL, CPA: The rule of thumb here is that your total debt payments should not exceed 36% of your GROSS income. So if you make $5,000 gross per month, your debt payments (including mortgage, car loan, student loan, etc.) per month should not total more than $1,800.
As far as total balances go, keeping your credit card balance to 30% or less of the available credit on each account is advised for the best scoring there.
Q: My husband and I are thinking of buying a house, but our credit histories are vastly different. Is there benefit to doing everything in the person’s name with the better credit?
KCL, CPA: You might consider putting the mortgage in the name of the person with better credit, especially if the other person’s credit is dismal, because you will probably be able to receive a better rate.
But here’s the caveat: you’ll only be able to use the “good” person’s income when applying for a mortgage, so it might limit you in terms of how much house you can buy. If Mr. or Ms. Awesome Credit also makes a ton of money (lucky!), then it shouldn’t be an issue. But most couples I know need both people’s income to qualify for what they want.
One other word of warning: opening up joint credit cards or other debt with someone who has poor credit can bring a good score down, so exercise caution there. If you want to share a credit card, I recommend opening up the account only in one person’s name then adding the other person as an “authorized user.” Best to keep credit history’s separate until you’re both looking good on paper.
What other questions do you have for future Q&A with a CPA topics? Let me know in the comments!