CREDIT SCORES
WHAT IS A CREDIT SCORE AND WHY IS IT IMPORTANT?
Anytime you apply for a credit card, a student loan, a car loan, or a mortgage loan, the lender will look at your credit score to determine the likelihood of the loan being repaid and therefore whether or not they will loan you money. The better your credit score is, the easier and less expensive it is for you to obtain credit. Some employers also check credit scores when hiring to determine who might make a good employee. Your credit score will follow you for your entire life.
Not only does your credit score determine whether or not you’ll receive financing, it also determines how much it will cost you to borrow that money. People with higher credit scores are deemed to be less of a risk, and therefore will typically receive the lowest interest rates. Those with lower scores are viewed as more of a risk, so the lender will offset that risk by lending you money at a higher interest rate. With larger loans such as buying a vehicle or a home, just an extra interest rate point could add up to thousands, and even tens of thousands of dollars wasted on interest over the life of the loan.
Most lenders will offer a lower interest rate to students who have a "credit-worthy" individual willing to co-sign their loan application. An individual who co-signs your loan application will be held legally responsible if you fail to repay your student loan. Most provisions in the Credit CARD Act of 2009 place new restrictions on credit card fees and interest rate policies.
FICO SCORES
Major lenders utilize your "FICO" score, which helps determine credit risk based on a number derived from your credit history. FICO scores provide the best guide to future risk based solely on credit report data and are the standard score provided to lenders by the major credit reporting agencies: Experian, TransUnion, and Equifax. Scores range between 350 (extremely high risk) and 850 (extremely low risk). The higher the credit score, the lower the risk.
WHAT MAKES UP A FICO CREDIT SCORE
A FICO credit score takes into account a lot of different information from your credit report, but it’s not all treated equally. Some aspects of your credit history are more important than others and will weigh more heavily on your overall score. Your FICO score is essentially made up of the following:
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- Payment history: 35%
- Total amounts owed: 30%
- Length of credit history: 15%
- New credit: 10%
- Type of credit in use: 10%
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The bulk of your credit score comes from your payment history and how much debt you actually have, which account for 65% of your score. These are the areas you’ll want to tackle first if working to improve your score.
CREDIT SCORE VS. CREDIT REPORT
A credit score and a credit report are two different things, although the credit score ultimately depends on your credit report. Your credit report is simply a detailed account of your credit history. The credit report will contain information such as:
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- Current credit accounts
- Payment history
- Credit inquiries
- Credit utilization
- Bankruptcy
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Your credit report itself does not have a FICO number. It is simply a report of your current and past credit history. Most credit history will only go back seven years, although bankruptcy will stay on your report for ten years. Even though the scores are based on the same credit report information, you may have differing scores from the three major credit bureaus in the United States because the scoring systems are based on different criteria, which are weighted differently. A FICO credit score is based off of your credit history, but it’s not actually a part of your credit report. Instead, the three major credit bureaus will calculate your FICO based on your credit history they have on file. This means you can have up to three different FICO scores at one time.
CHECK YOUR CREDIT
You are entitled to a free copy of your credit report from each of the three major credit reporting agencies once a year. You can obtain these free credit reports from annualcreditreport.com. Call 1.877.FACT.ACT (1.877.322.8228) for more information.
You should review your credit report annually. Mistakes might be found on the report, which could negatively impact your credit score. Some mistakes could result from having a common name, a junior or senior in the family, or identity theft. A report could also reveal a medical collection that you did not even know about. Despite paying a medical bill, a clerical error could lead to inaccurate posting.
Your FICO score does not come with your credit report, and it isn’t something you’re entitled to annually. You may have to pay a fee to receive your score.
IMPROVING YOUR CREDIT SCORE
What happens if you have made some mistakes in the past and now your credit score is low? Don’t worry. The good news is that your credit score is constantly updating, so every month as you begin to make improvements to your credit history, your score will be sure to follow. But keep in mind that items on your report will stay there for seven years, so it will take some time for serious negative marks to eventually disappear completely.
Thankfully, there are a number of things you can do to improve your credit score. Start with the basics and make sure you’re making all of your payments on time. Remember, payment history is the single greatest factor in your credit score. If you make payments over time, you’ll slowly start to raise that score. Second, reduce your total amount of debt. The second largest impact on your score is how much debt you have, so if you can put a dent in your overall debt, you’ll also begin to make some serious headway. But don’t stop there:
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- Pay down your credit cards.
- Don’t use your whole credit line every month.
- Is your credit report correctly reporting your credit limits for your cards? If not, you can call your credit card issuer and ask them to update the list. You can also challenge the limits with the credit bureaus.
- Don’t use credit card issuers who don’t report your credit limit.
- Ask a trusted friend or family member to add you to one of their old cards as an authorized user.
- Ask a creditor for forgiveness.
- Get student loan payments current.
- Dispute old negatives.
- Get a collection agency to agree to remove a debt from your report if you pay it.
- Dispute with original creditor.
- Target “easy” errors — negatives that truly are not yours.
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ADDITIONAL CREDIT SCORE RESOURCES
Understanding your credit score
Suggestions for improving your credit score if you have had credit problems in the past
Check Your Credit Report (FTC)
Your Credit History (consumer.gov)
Understanding Credit (Equifax)
