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Q: My credit scores were around 780, but that was before I had two 30 day late payments in 5 months on the credit card with Chase which I am currently settling. I had to take a much lower paying position and don't have other options but to settle. The debt settlement deal is quite good, Chase accepted $3,500 for $12,800 balance. Wells Fargo and Capital One will be next. My main concern is how debt settlement affects credit score? Where would the scores be and how long it would take for them to recover?

A: Before we dive into debt settlement, the obvious point is that two 30 day late payments already lowered the credit scores by probably 170 points, so your score is at 610 to 620 range. With these late payments alone, it would take over 2 years for credit scores to recover may be 50 points or so, because you were late twice on the same credit card, as was mentioned in 30 day and 60 day late payments.

Once you reach debt settlement with Chase and it gets recorded on your credit report as such, and affects the credit score further, dropping it by another 25 to 40 points. The reason is obvious - settling a credit card debt means that the lender agrees to accept less than the amount owed on the account, thus indicating a higher level of risk. Since your credit score had already lost quite a few points, the debt settlement impact would be less severe. Remember, the higher the scores, the lower they fall when derogatory information is reported.

You did set up a very straightforward debt elimination plan and have to stick to it. When you are done settling with Chase, debt settlement deals with Wells Fargo and Capital One will likely take another 40 to 50 points of the credit score. See What affects credit score according to FICO.

Thus by the time you finish, 3 debt settlements combined with 2 late payments will affect your credit score by around 250 points, and you will be looking at 530. And it may take up to 3 years of impeccable credit history to recover the scores to the mid 600s level.

The important thing is that most of the damage to scores was done by the missed payments. At this point, the impact of debt settlement on your credit score is rather secondary. You managed to settle for 27% with Chase and getting similar or even lower percentages with Wells Fargo and Capital One should take precedent over any other concerns.

The other crucial element is that by settling debt before it is assigned to a collection agency, you can eliminate potential future problems,
- having two negative records reported on the same debt - one with original creditor, the second with collection agency
- dealing with debt reaging issue, practised by many collection agencies
- seeing you credit score dropping very significantly after debt settlement with collection agency should you achieve it

Of course, before paying off the negotiated settlement amount, you can try to convenience creditors to stop reporting previous late payments and report account status as Paid As Agreed / Closed by Consumer Request. You can also get debt collection agency to drop the collection from the credit report. Those would affect your credit score very positively, boosting it at no time. Read
Negotiate credit card debt yourself for useful tips.

The bottom line is while typical debt settlement affects credit score negatively, in addition to preceding late payments, you can always try to minimize the damage. The most important task is to liquidate excessive debt. You can establish credit anew after you settle.

You can find plenty of advise and instruction, some good and some not so, on how to establish credit. The other question that a lot people ask these days is what time is needed to establish credit history to be able to get loans. Interest rates have been low for a long time and seemingly everyone expects them to go higher. Home prices have been going lower every day and just as well, everyone thinks that they are bottoming and will bounce back. So every new college grad with a job or a fresh of the boat immigrant is in a hurry to establish credit history, get the credit score and score that house.

For the record, I think that interest rate will stay low for quite a while, while home prices will be going down, albeit slower. But then, you still will listen to CNBC and Bernanke. That does not change the fact that time to establish credit is at least 6 months. However to qualify for a home loan, you need more time, at least 24 months and a couple of trade lines.

Why it takes that long to establish credit history and get FICO score? Because the FICO score is a risk score by definition, so to predict the risk that you will default on your credit obligations, it needs a track record and 6 months is actually quite short of a term. At the very minimum, you have to meet the following criteria,
- one account that has been open for 6 months
- one undisputed account that has been reported to the credit bureau within the past 6 months
- no indication of deceased on the credit report, so if you share an account this may affect you if the other account holder is reported deceased

Once you have a credit card, use regularly it and pay off the balance if you wish monthly or carry a balance. It does not really matter as long as you meet minimum monthly payment requirements. Your initial credit score will be around 680. You then should get a second credit card and as long as your debt utilization is around 10% to 15%, your FICO credit score may well reach 720 in another 6 months.

To obtain a mortgage, you may want to wait for another 18 months. That will give you a good 24 months of at least two credit trade lines and a nice credit score. You can always try applying for a mortgage before that, and as long as you have a bigger down payment, you may well qualify.

The one thing I could never understand is the people fixation with average credit scores. Why would you care to know what is the average credit score in your state, in any other or in the entire country? It does not help you in any way, shape or form - yet you can find many sites that show you just that. Does living in the state with higher average score make you feel better? And when it comes to your own situation, for the vast majority of lenders, the most important credit score is the one at the middle.

If you need a mortgage, your potential lender pulls tri-merged credit report with scores from Equifax, Experian and TransUnion. That used to be called the FICO score, but since Experian is no longer associated with FICO, we can call it something else. Doesn't matter, you still have three different scores, e.g. 680, 690 and 730, and the mortgage rate, fees, etc. will be based on the in-between or middle credit score of 690, not the mathematical average credit score of 700.

The reason you have different credit scores among the three credit agencies is because each uses slightly different scoring algorithm, gets somewhat different data and weighs that data a bit differently from the others. The credit scores can be as close as few points or as far as 50 or 60 from each other. Again, the only one that really matters is the credit score in-between.

And if you apply for something less significant than home mortgage, a car loan for example, one credit score is all a dealership financial person typically looks at. No need to worry about average credit score here.

Having drastically higher average credit score than that of your spouse sometimes presents a problem. Especially if your incomes are quite different, and you and the spouse are applying for a mortgage together to use both incomes in order to qualify. Both will be on the mortgage application. Normally, the spouse with the higher income is a primary borrower, whereas the spouse with the lower income is a co-borrower.

In ideal scenario, primary borrower has higher income and higher or close to that of the co-borrower average FICO credit score. But that is not often the case, so what happens when the co-borrower spouse has higher credit score?

If the average FICO score of the higher earner is only lower by 20 to 25 points than that of the spouse, he or she can remain primary. More importantly, the credit score should not fall into a different credit rating category. This is the case where your lender can switch you and the spouse on mortgage application with no consequences, giving you the same interest rate, fees as quoted before.

If the above conditions are not met, than a spouse with higher average FICO should become primary and the other becomes co-borrower. The only condition is that the income of the new primary borrower is not lower by a lot. If this condition can not be met, than, the borrower with lower average FICO credit score and higher income remains primary borrower and interest rates and fees of the mortgage are likely to be higher.

By how much the income of the lower-earning spouse can be less than that of the higher-earning to become a primary borrower? A lot depends on the mortgage amount, assets and sizes of the salaries, but in general, the difference should not exceed $15,000 to $20,000. If the higher-earning spouse has average FICO score low enough for interest rate and fees to go too high, he or she must work to establish credit prior to applying.

If you have several credit cards and carry balances on more than one, it is important to stay proactive and pay attention to each card limit. Lowered credit limit on a card with balance increases the credit utilization rate and often makes credit score go down. If two or three issuers have your credit card limits lowered, the scores will likely go down quite significantly.

Who is the most vulnerable to such a scenario? Credit card holders who transfer balances at 0% percent interest on two or three cards and set up monthly automatic payments. And with banks lowering credit card limits, it is easy to suddenly discover your utilization rate is too high and credit score went down 50 or more points.

Check credit card limit often
Every time you login into the account, look at it carefully. Often, bank send neither timely letters nor emails. On many occasions, consumers learn their credit card limit lowered to the point the utilization rate is over 90%. I know it sounds too far fetched, but if you look at the numbers, it is not so. Suppose you transfer $3,000 on the credit card with $10,000 limit. 30% credit utilization rate is just fine. Then for one reason or another, the bank lowers the credit limit to $3,300, giving you a very bad 91%.

Now imagine someone with more than one credit card, where balances are just $100 under the limits. The good credit score will not just go down, it will drop like a rock. Worst situation is when a credit limit matches balance, putting you at 100% credit utilization rate.

If your credit card limit is lowered, what can you do
Unfortunately not much. You can try to ask the bank or banks very politely what can be done to fix it. Never close credit cards which you don't use, to placate the issuers of the ones with balances. If you do, there is no guarantee, your credit limits will be raised and you will loose not only use the just-in-case credit lines, but lower credit scores even more.

Don't think of transferring balances on other credit cards, unused or with higher limits as some advise. First, it will cost you 3% to 4% of a transferred balance, which is a typical transfer fee all 0% interest offers now come with. Second, if you leave a balance on credit card which causes your grief, it likely lower the limit again. Here is to clarify -
credit card 'A' has $4,000 balance, $4,200 limit, 95% utilization rate - very bad
credit card 'B' has $0 balance, $3,000 limit, 0% utilization rate - excellent
your combined credit utilization rate is sum of balances ($4,000) divided by sum of limits ($7,200), yielding 55% - quite bad but somewhat bearable

You transferred $1,000 from credit card 'A' to credit card 'B', so now you have -
credit card 'A' has $3,000 balance, $4,200 limit, 71% utilization rate - slightly better
credit card 'B' has $1,000 balance, $3,000 limit, 33% utilization rate - good
your combined credit utilization rate is still the same 55% - $4,000 divided by $7,200

But the issuer of credit card 'A' is not done, as it lowers its limit to $3,200. You are now back to 94% utilization rate on this card and your combined rate is 64% - $4,000 divided by $6,200.

What you can do
Log into your account and look at the Alerts. You will certainly have one like Credit card balance within $_____ of card limit. Put a $ amount that makes sense and activate it. Of course, having an alert stating something like Credit card limit is lowered would be much better.

You should watch credit card balances carefully, especially if credit limit is equal to or only slightly higher than balance, because monthly interest may very well put you over the credit limit, and then you have over-the-limit fees added. That will force your credit score go down even more.