The Importance of Knowing (and Understanding)
Your Credit
Score
Think back to the last time you applied for credit. It could have
been for a new credit card, a car loan, mortgage refinancing or line
of credit at the bank. In any case, you probably recall being told
that your credit report was being pulled so that the lender could evaluate
your creditworthiness.
While examining your credit reports from the three major credit bureaus
– Experian, Equifax and TransUnion – the lender also took a look at
your credit score. A credit score is a number, derived from the data
in your credit reports, that allows lenders and others to predict your
likelihood of making timely credit payments.
Why Credit Scores Matter
Credit scores help determine whether you receive the credit you applied
for, and what your interest rate will be. The higher your credit
score, the more likely your approval, and the better your rate. A
low credit score, on the other hand, can preclude you from receiving
credit, or result in your receiving a substantially higher interest
rate – costing you significant money.
The credit score used by the vast majority of lenders for many years
has been Fair, Isaac & Co.’s FICO score, which ranges from 300
to 850. The most favorable credit terms are typically available to
those with scores above 760. The lower your score, the worse your terms.
Scores below 600 are considered high risk and may even prevent your
receiving credit.
For example, in Georgia, a borrower with a FICO score in the 760-850
range would receive a rate of 6.094% on a 30-year fixed-rate mortgage
(as of Aug. 30), resulting in a monthly payment of $1,514. A borrower
with a score in the 620-639 range would get an interest rate of 7.684%
on the same loan, with a monthly payment of $1,780. That’s a difference
of $266 a month, or $3,192 a year. Over the life of the loan, the borrower
with the lower FICO score would pay a whopping $95,760 more.
The influence of credit scores reaches beyond credit and interest
rates, however. Scores can also affect your ability to rent an apartment,
buy a cell phone, or even get a job. They may determine how large the
deposit you must pay to start electricity, natural gas or telephone
service. And they can affect the premiums you pay for private mortgage,
auto and homeowners insurance.
FICO Still Dominates
Many different companies and agencies produce some type of credit score.
Insurance companies use something called a “credit-based insurance
score” in determining insurance rates. Some lenders use proprietary
scores as well. Each of the three credit bureaus also produces its
own credit score. And earlier this year Experian, Equifax and TransUnion
launched VantageScore to compete directly with the FICO score.
Still, in the credit world, most lenders continue to use the dominant
FICO score. On the web site www.MyFico.com you
can buy your FICO score and all three credit reports for $15.95, as
well as view the interest rates that correspond to your score. As listed
on the site, a FICO score is made up of five components:
Your payment history accounts for about 35% of your score. “Have you paid your credit accounts on time? Late payments, bankruptcies
and other negative items can hurt your credit score. But a solid record
of on-time payments helps your score.”
How much you owe makes up about 30% of your score. “FICO scores look at the amounts you owe on all your accounts, the
number of accounts with balances, and how much of your available credit
you are using. The more you owe compared to your credit limit, the
lower your score will be.”
The length of your credit history is about 15% of your
score. “A longer credit history will increase your score. However, you can
get a high score with a short credit history if the rest of your credit
report shows responsible credit management.”
New credit makes up about 10% of your score. “If you have recently applied for or opened new credit accounts, your
credit score will weigh this fact against the rest of your credit history.
FICO scores distinguish between a search for a single loan and a search
for many new credit lines, in part by the length of time over which
inquiries occur. If you need a loan, do your rate shopping within a
focused period of time, such as 30 days, to avoid lowering your FICO
score.”
Other factors account for about 10% of your score. “Several minor factors also can influence your score. For example,
having a mix of credit types on your credit report – credit cards,
installment loans such as a mortgage or auto loan, and personal lines
of credit – is normal for people with longer credit histories and can
add slightly to their scores.”
Tips for Managing Your Score
Understanding the components of your FICO score can help you influence
your score over time. Keep in mind that maxing out a credit card
(if it’s the only one you have) can wipe 80 points off your score
immediately, and missing a credit payment can result in a 100-point
hit. You could easily fall from the best credit score range to one
of the worst very quickly.
Rebuilding your damaged score takes much more time, however. Negative
items can affect your score for up to seven years, but their impact
lessens over time. Paying off the card you maxed out, for example,
adds points back to your score. And not missing another payment for
an extended period of time also has a positive affect.
The best advice is to stay out of trouble in the first place. But
if you do slip up, work hard to boost your score. Here are some ways
to help:
Pay your bills on time.
Keep balances low (as a percentage of your total limit) on credit
cards.
Pay off credit card debt instead of shifting it between cards.
Only apply for and open credit accounts when you need them.
Check your credit reports regularly and fix errors immediately.
If you have missed payments, get current – and stay that way.
