Lately it seems like everyone is a slave to their credit report. I have an old friend who just went through a bout of unemployment, where she nearly lost her apartment and her car. She has some medical bills coming due, as well – and she’s very stressed out about her credit report.
Well, you don’t have to enslave yourself to your credit report. There are lots more important things to worry about, and if you are having trouble managing the basics, such as food, shelter, clothing, and transportation so you can stay in the work force – well, take care of that, first, before stressing about what it might say on your credit report.
That said, however, your credit score is more important than it used to be. It’s not just lenders who look at credit scores, anymore. More and more employers look at your credit report when applying to certain jobs. And many landlords will “pull a bureau” on you before deciding whether to lease an apartment to you. Even auto insurers are getting into the act: granting auto insurance premium discounts to people with excellent credit scores.
Let’s take a closer look at your credit score, what goes in it, and how you can improve it.
Your FICO Score and Its Applications
Your credit score is also known as your FICO score, which stands for Fair, Isaac Corporation. This is a company that consolidates your credit information from the three major credit bureaus, and consolidates it into a score. Lenders look at your score as a proxy for how safe a credit risk you are. If you have a spotty credit record in the past, statistics say you are likely to have a spotty credit record in the future.
Sure, there are always exceptions. But lenders are in the business of playing the percentages. They don’t know you personally, in most cases, so all they can go by is your credit score and the collateral you present.
FICO credit scores range from 300, which is bad, to 850, which is pristine. Your score calculation is automated. It happens automatically, and your credit score is updated every time your credit information is updated, or when information “scrolls off” your report after a certain period of time (between seven and ten years.).
To get the very best loans available, try to have a credit score of above 760 or so. The lower your score, the higher your interest rates are likely to be, and the higher your required down payment is likely to be on real estate purchases, auto loans, and the like.
Fair, Isaac’s exact algorithm is proprietary: They haven’t released their exact methodology to the public yet. But we do have a pretty good idea of what information they use to calculate your score and how it is weighted.
Your Credit Score: The Ingredients
The biggest and most important part of your credit score is your payment history. According information publically released from the Fair, Isaac Corporation, your payment history accounts for some 35 percent of your credit score.
First of all, FICO looks at whether you have any major legal marks on your credit record. For example, any bankruptcies you have incurred, judgments from lawsuits, wage attachments, tax liens, etc.
These are the most serious issues on your credit report, and some of them, such as a Chapter 7 bankruptcy, will not scroll off your report for 10 years, as opposed to the seven years most information stays on your report.
FICO tracks your payment history on all debts reported to any of the major credit bureaus, including credit card debt, retail cards such as a Sears card, installment debt, finance company loans, mortgages, etc.
They look at how reliable you are with paying them off, including how severe any delinquencies are. A few 30-days delinquencies, here and there, over a period of years, is no big deal. But a history of 60 day and 90 day delinquencies is going to sting your credit score for a while.
They also look at the number of items you have past due, as well as the number of accounts you have paid off as agreed.
Amounts You Owe
The second most important factor in calculating your FICO score is the amount of debt you hold on various types of credit accounts. Of particular importance: Your debt-to-available credit ratio. This is your total balance, divided by the total amount of all credit lines open to you. For example, if you have open lines of credit and credit card limits totaling $50,000, and you hold a balance of $10,000, from all sources, you have a ratio of 20 percent.
For a solid credit rating, strive to pay off all your bills on time, as agreed upon, and keep your debt to credit ratio below 25 percent, and ideally below 10 percent.
This is particularly important when it comes to qualifying for a mortgage, since your debt to total income ratio factors very prominently as well.
According to the Fair, Isaac Corporation, it is also helpful to prove your responsible handling of several types of credit. For example, to maximize your credit score, you may want to hold a small, easily manageable balance on one or more credit cards, an installment loan on an appliance, for example, and a car loan.
Warning: This advice may help you goose your credit score slightly, giving you a way to “game the system.” Opening up several balances may be the best thing for your FICO score. But it may not be the best thing for your overall financial situation. In the end, an interest rate of zero is better than an interest rate you’re paying to someone else! For some people, it’s better to avoid consumer debt altogether and pay cash, accepting a lower credit score, than it is to rack up credit accounts and risk getting into trouble.
Length of History
When it comes to your credit score, length does matter. It helps your score to keep an account open for a long time. Good credit histories that go back years are stronger than good credit histories that are very new.
New Credit Accounts and Inquiries
The sudden opening of a number of new credit accounts raises a red flag among creditors, as does a large number of applications for credit within a short period of time. If you are planning on taking out a big loan for anything, such as a mortgage, try to avoid filling out a whole bunch of applications in the weeks and months before you’re ready to buy.
Note: FICO understands that it is quite normal to fill out several applications for the same loan — say, a mortgage loan — at different companies. They typically don’t count this process against you when calculating your score.
So how can you boost your score?
- Keep your old accounts in force. If you have to cancel one of two credit cards, cancel the newer one, all things being equal.
- Pull your own credit report once each year (it’s free!) and inspect it for errors. If you find errors, notify the bureau, in writing. By law, they have 30 days to strike false information from your report. Otherwise, they must verify the accuracy via the merchant that filed the adverse report.
- Inspect your credit report carefully for forgotten accounts, charge-offs, and delinquencies. Either challenge them or correct them.
- Don’t cancel cards right before applying for a big loan. This will not change your debt, but it will lower your available credit amount without changing your balance, which will adversely affect your debt/available credit ratio.
- Protect your card number from compromise by identity thieves. Write “Check ID” on the back of the card. Get one with a photo on it. When paying with a credit card over the Web, only use encrypted Web sites (you can tell by the “https://” prefix, and/or by the tiny padlock symbol displayed on your browser.
Above all, don’t treat your credit report like a golden calf, worshipping it like an idol. It is useful if you want to borrow money. But there is a lot more to your financial life than your FICO score.
The good news: No matter how bad your credit history, you can always improve it by paying off your debts on time and managing your fiancés responsibly. Newer credit information is weighted more heavily than older information. It’s never too late turn over a new leaf. And there is no reason why you can’t have a score of 850 in seven years.
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