Your Credit Score
Your credit score can have a major impact on your life. Not only do creditors typically check your score when deciding whether or not to approve your application and what interest rate to charge you if you are approved, but landlords, insurance companies, and even employers often check it as well. Having a good score can help you achieve your goals quickly and at the lowest possible cost.
What is a credit score?
Your credit score is a mathematical assessment of the likelihood you will repay what you borrow. It is based on the information in your credit report, which tracks your credit-related activity. Types of credit include credit cards, store cards, personal loans, car loans, mortgages, student loans, and lines of credit. For each account, your report shows who it is with, your payment history, the initial amount borrowed (for loans) or credit limit (for revolving credit), the current amount owed, and when it was opened/taken out. Your report also shows if you have experienced any credit-related legal actions, such as a judgment, foreclosure, bankruptcy, or repossession, and who has pulled your report (called an inquiry). There are three major credit bureaus that compile and maintain credit reports: Equifax, Experian, and TransUnion. Theoretically, all three of your reports should be the same, but it is not uncommon for creditors to report to only one or two of the bureaus.
The most commonly used scoring model is issued by the Fair Isaac Corporation. Called a FICO score, it ranges from 300 to 850, with a higher score being indicative of less risk. Generally, those with a higher score are more easily granted credit and get a better interest rate. While there is no standard for what constitutes a good credit score, one benchmark to keep in mind is that it is very difficult to get a mortgage if your score is below 580 (and many lenders require you to have at least a 620 or higher), and to get the best interest rate, you usually need at least a 760.
The following are the factors that are used to calculate your FICO score:
- Payment history (35%): Making your payments on time boosts your score. Conversely, if you make a late payment, your score will take a hit. The more recent, frequent, and severe the lateness, the lower your score. Collection accounts and legal actions have a serious negative impact.
- Amounts owed (30%): Carrying large balances on personal loans and revolving debt, like credit cards, particularly if those balances are close to the credit limits, will lower your score.
- Length of credit history (15%): The longer you have had your accounts, the better.
- New credit (10%): This factor looks at the number and proportion of recently opened accounts and the number of inquiries. While many inquiries on your report will lower your score, all mortgage or auto loan inquiries that occur within a 45-day period are considered just one inquiry for scoring purposes. Accessing your own report is not damaging to your score nor are inquiries for pre-approval offers. Having new accounts can hurt your score, but if you have had a history of late or irregular payments, reestablishing a positive credit history will be taken into account.
- Types of credit used (10%): Having a variety of accounts, such as credit cards, retail accounts, and loans, boosts your score.
Since your Equifax, Experian, and TransUnion credit reports do not necessarily contain the same information, your FICO score from each bureau may be different. When you apply for credit, the creditor may only check one of your scores or check all three and average them or take the lowest or middle score.
Improving your score
Following these habits can boost your score:
- Always pay on time: Your payment history makes up the largest chunk of your credit score, so making your payments on time is extremely important.
- Pay down existing debt: Even if you have never missed a payment, a large debt load will lower your score. Explore ways you can lower your interest rates and free up cash to make more than the minimum payments.
- Avoid taking on additional debt: Besides paying down existing debt, make an effort to not take on more debt in the future. For revolving credit, ideally you should not charge more than you can pay off in full the next month, but at the very least, try to keep the balance well under half of the credit limit.
- Check your report for errors: Many reports contain score-lowering errors. Check your credit report from the three bureaus at least annually, and send a dispute letter to them if you notice any errors. You can get a free copy of your report once a year from the Annual Credit Report Request Service.
- Keep your old accounts: A long credit history with the same accounts indicates stability.
- Limit balance transfers: While transferring balances to “teaser rate” cards can be a way to efficiently get out of debt, it can also have a detrimental effect on your credit score. The accounts will be new and likely have balances close to the limit to maximize the advantage of the low rate – two factors that lower your score.
- Avoid excess credit applications: When you apply for credit, your score decreases just a bit. If you do it frequently, a creditor may see it as a sign that you need to rely on credit to pay your bills.
- Be patient: It may feel like credit mistakes can haunt you forever, but remember that your payment history from the past two years is much more important than what happened before that. Also keep in mind that most negative information is removed from your report after seven years.
Obtaining your score
When you apply for credit, the creditor may provide you with your score at no cost. Otherwise, if you want to see your score, you typically have to pay for it. There are a variety of services that sell different types of credit scores, so when you are purchasing your score, it is extremely important to pay attention to what exactly you are getting. Since it is the mostly widely used, it generally makes the most sense to purchase your FICO score. However, even then, keep in mind that you may not be seeing the exact same score a lender will see. (There are different versions of the FICO score available. Additionally, there are many creditors that use an internally-created scoring model in conjunction with or in lieu of the FICO score.) Checking your credit score can be helpful if you are planning to get a mortgage or car loan soon and want to have an idea if you will get approved or qualify for the best interest rate. However, otherwise, you may just want to stick with checking your credit report, which is available for free. Remember, your score is based on the information that is in your report.
Fair Isaac Corporation
Annual Credit Report Request Service