One of the most important things that you should learn about your finances is your credit score. This figure is used to determine a lot of things about your credit risk. There are various uses for it and this page will help you understand what they are and how it can affect your life.
What is a Credit Score?
This score is computed based on the credit report that the three major credit bureaus (Equifax, TransUnion and Experian) have gathered about you. They gather your data from banks and other financial institutions that you have dealt with. Your credit history will affect how your credit score will come out. It is computed through a special formula that grades 5 different points of your credit history.
A credit score is the numerical value that will measure your creditworthiness. It indicates how you handle your finances, your ability to pay off a debt and your payment behavior. Lenders need all of this information to determine if you are a high risk borrower or not. The lower your score is, the higher you are graded as an investment risk. If you are found to be very risky, they will have to take steps in order to protect their investment.
The credit score looks at both the positive and negative aspects of your credit data. Even if you have a lot of debts, it is possible for you to have a high score – at least if you are good and diligent with your payments. Also, if you have no credit cards or accounts (thus you have no debts), you will most likely have a low score. This is because there is no data supporting how well you can pay a debt or not – thus making you a high risk borrower.
About FICO Score
When you read about credit scores, you will most likely encounter the name FICO score alongside it. FICO stands for Fair Isaac and Company – the developer of the software that computes this number. There are other software developed after this but this is the most commonly used by lenders. If you want to know the score that they will see, it is best to use this software as well.
The three credit bureaus have come up with their own software to compute for this score. TransUnion uses EMPIRICA, Equifax uses the BEACON Score and Experian uses the Experian/Fair Isaac Risk Model for their own computations. They are all known to have patterned it from the original software of Fair Isaac and Company. These software are constantly developed to come up with a more accurate formula for the credit score.
Factors Not Affecting your Credit Score
The great thing about credit scores is it allows lending approvals to be unbiased. Before its existence, people are judged by lending companies based on uncontrollable factors like age, sex, religion and nationality. These used to be part of what lenders consider when gauging how well you can pay back the loan that you are about to take. Now, only facts and figures are used – thus making sure that women and minorities have as much chance to get a loan approval as anyone.
In analyzing your score, the software will look at 5 areas in your credit history. We will be using the formula of the FICO score as it is the most popular software used by lenders.
Payment History
The first and the most influential is your payment history. It constitutes 35% of your credit score. It will look into your behavior in paying for credit cards, mortgage loans and other installment accounts. This also includes your retail accounts – if any.
A late payment or two will not drag your score down – even if it is the most recent payments. It will take into account your payment behavior as a whole. Negative factors that can have drastic effects on this figure includes lawsuits, bankruptcies and foreclosures.
It may be important to note that this considers the number of accounts that you have no late payments. So if you were delinquent in only one account and good in the others, your score will not be too low.
Debts
The next factor affecting your credit score is the total amount of debt that you have. This credit score factor comes in at 30% of your score. The thing is, even if you have a lot of debts with other lenders, that does not automatically make you a high risk borrower. This system takes into account your ability to pay off your debts. As long are your credit cards are not maxed out or overtaken by the amount of what you owe, then your credit score should be in good shape.
The software examines not only the total amount of debt but the amount for each type of account (e.g. credit card, loan, etc). It also determines the number of accounts with low balances and those who have been paid completely.
Credit History
The rule for this factor is, the longer you have an account, the better it is for your score. This amounts to 15% of your overall credit score.
Bottom line is, age matters. It counts the number of accounts that you have, how long you have had them under your name and the average age that your accounts have been active.
Your score will also be affected by how often you use certain accounts like your credit cards. If they show that you use it often and yet your balance is low, then that will reflect a high score. On the other hand, if you are not using your card much and yet you have a high balance, then that does not bode well for you.
New Credit
Separate from your total debt, the FICO score checks the new accounts that you have opened. Having a lot of accounts with a short credit history will not give you a good score – at least for 10% of your credit score..
It is best not to open too many accounts at the same time as it shows that you are a risky borrower. Remember that the average age of your accounts is computed. A new account will lower that age significantly. For instance, if you used to have 3 accounts that are active for 5, 7 and 9 years respectively, you should have an average of 7 years. But if you suddenly open 3 new accounts simultaneously, that will lower your average age to 4 years – almost half of what you used to have.
Another important note is the inquiries on your credit report. This is also examined by the FICO score but it is weighed in terms of what affects your creditworthiness. It is not necessarily true that if a lot of lenders inquired about your credit report, your score will go down.
Types of Credit Used
The last factor completes the final 10% of your FICO score. The software checks the credit mix in your history. Do you have both revolving and installment accounts? It does not necessarily have to be one of each but the important element here is how many of them you are using.
Also, it has to be noted that a person with no credit card is considered a higher risk than someone with multiple credit cards yet low balances.
This is also where closed credit cards affect your overall score. Basically, if your credit card is deep in debt, do not close that account immediately. That reflects badly on your score.
Who Views your Credit Score?
You credit score is viewed by lenders whenever you have an application with them. While they are the primary users of this report, it is not really exclusive to them.
Banks and other financial institutions will look at your score before they approve of your account. This is also true for credit card applications. They will see just how diligent you are in paying off your credit card debts. The same is true for insurance agencies and any other company that will require monthly payments from you.
Surprisingly, even employers look at the credit history and score of an applicant prior to hiring them. A well managed financial standing speaks a lot about how mature and responsible a person is. This is, of course, not a huge factor but nevertheless, it is one of the components involved in their investigation of your background check.
And speaking of investigations, any financial case that you are involved in will definitely tap into your credit score.
If you own a business with a sole proprietor type of ownership, your personal finances will be directly entwined with your business. Given that condition, you have to take care of your credit score – especially since your future business will require a loan or two.
Landlords even check your credit score before allowing you to live in their property. That will assure them that you are able to pay for your rent and you will not be a headache come collection time.
Benefits of Knowing your Credit Score
Most of the time, people encounter this number when they apply for a loan. However, it is very important that you try to monitor it regardless if you have a financial need or not.
For one, it will help you monitor if you are still maintaining a good score or not. Even if you have no immediate financial need, it is important to take care of your credit report. Your credit history reaches as far back as 7 years. What may seem unimportant to you right now may be needed in the future. If you see that your credit score is dropping, you can work on improving it before it reaches a point where it reflects badly on your financial reputation.
Another reason to know your score is to detect identity theft as they happen. If you are looking at your credit report regularly, you will know if someone suddenly opened an account under your name. When that happens, you can immediately act on it to stop further theft.
If it is not identity theft, you can at least check for any errors. Credit reports can contain erroneous data too. It stems from the fact that the credit report is incorrect to begin with. Sometimes, clerical mistakes happen. A wrong digit in the account number can result in someone else’s loan being credited to you. If you have been monitoring your credit score, this is something that you can immediately detect and dispute.
Monitoring your Credit Report and Score
Monitoring your credit report can be easily done without any cost. The three major credit bureaus (Equifax, TransUnion and Experian) are all mandated by the government to release one free credit report for Americans each year. This free report is available at AnnualCreditReport.com.
A great tip to monitor your credit without spending anything is to time your ordering of the three free credit reports. For instance, you can get the report from TransUnion in January, Experian in May, and Equifax in September. That way, you can spot anything that needs correcting or investigating.
When you have your report, look into the various credit score calculators that are made available on the Internet. Input the details stated on the report that you have and run the program to get an estimate of your credit score.
How to Fix a Wrong Credit Report
In the event that you find a wrong information on your credit report, you don’t have to take that sitting down. You need to file a dispute to correct that mistake.
The Fair Credit Reporting Act state that the credit bureaus and credit companies have a responsibility to correct any inaccuracies found on their reports. It also states that you have the right to receive a copy of your credit report. To view more about this act, visit the FTC main website.
Once you have proof that your report contains incorrect information, you need to write a formal request to the credit bureau that released it. Indicate the mistake by sending a copy of the report you received, show the proof that it is in error and request for a revision or deletion – whatever is applicable. Send this by mail and request for a return receipt so you can document the date and time when your request was received. The bureau has 30 days upon the receipt of your letter to investigate and act accordingly.
If you are applying for a loan and the process is in effect when you found out about the mistake, write your lender or creditor a letter stating that you are disputing a detail on your report. That way, they know that a particular information is in question and will wait before deciding to approve of your request for a loan or any form of financial assistance.
You should receive an updated credit report from the bureau with the correct information once they have acted based on their investigation. This copy is free and you should not be charged for it.
Importance of a Good Credit Score
Having a good credit score standing opens a lot of doors for you in the financial world. It simply means that you are not a credit risk. That is not because you do not have any loans but because you know how to pay them diligently.
Here is a list of benefits that a good credit score can give you.
Faster Loan Approvals. You will never know when you need the financial aid so it is best to maintain a good credit score to make sure that it will not hinder you from what you need. Since you have proven that you can handle loan payments and you are not a collection problem, you will be granted a loan approval easily.
Lower Interest Rates. Apart for fast approvals, you will enjoy the benefit of low interest rates. People with bad credit scores will not necessarily be disapproved but they will be given higher interest rates.
Opening Accounts Become Easier. Financial institutions such as banks and credit card companies look at credit scores when you open an account. Seeing how well you manage your finances will open these doors for you.
Employment Possibilities. Nowadays, employers take a peek at credit scores to view a person’s responsible characteristics. Finances are some of the hardest areas to manage and control and it definitely speaks a lot about a person’s work ethics and sense of responsibility.
Business Partnerships. If you are a businessperson, you will find that having a good credit score will open a lot of valuable partnerships. Some companies view credit scores before deciding if they will push through to invest in a joint venture or not.
What Happens with a Bad Credit Score?
Normally referred to a sub-prime rating, a bad credit score lessens your options and flexibility in availing loans and credit approvals. It could even mean outright disapproval if you end up applying with a very strict lender. However, this is not always the case as a poor credit score can get a loan approval.
But the catch there is a higher interest rate for your loan. Since you are a high risk borrower, the lender has no choice but to protect themselves by forcing you to pay high rates.
Let us assume you applied for a loan of $100,000 with a payment term of 30 years. A credit score of 760-850 (a good score) will mean a total interest payment of $55,000. But if your credit score is around 620, your total interest payment an amount to $88,000. That is a difference of $33,000. The lower your score is, the higher the interest rate that you will have to pay for.
Think of all the savings you will get just by having a good credit score.
Raising your Credit Score
The good thing about your credit score is it will not stay that way. While your credit history will hold your spending and payment behavior for years to come, that is not the same for your score. Although it is not really a quick fix, the bottom line is – it can be fixed. So if you have plans to take out a mortgage in a year or so and you have a bad credit, you need to start working on your credit now.
Taking care of your credit score is likened to achieving your ideal weight. It is not something that happens overnight. It needs constant work. And even if you have reached your ideal weight, the effort does not stop there. While it is not as hard as your initial efforts, you need a plan to maintain what you have achieved.
The reason why your credit score will not improve overnight is because your payment history constitutes to 35% of your score. But 30% of it is your debt total so that should be a good place to start.
Paying off your debts completely will not increase your debt immediately so you don’t really have to make big rash payments. You can continue paying them off in installments – as long as you do so on time.
It helps to set up reminders of your monthly payments so you are reminded a few days before a due date. Planning what budget goes to what is very important. That way, you do not end up spending more than you have to for unnecessary items. Make sure you identify your budget for basic necessities and those for your debts. Anything in excess should be put away as savings. If you have more than enough, you can get a limited amount for entertainment purposes.
You have to impose strict rules about your spending – at least until you have managed your debts to a level that will allow you to be extravagant. Wise spending does not really mean you have to be frugal – it means you know where to put your money where it is obliged to be.
Here are some more tips for you to use to raise and maintain your credit score:
– Pay your financial obligations on time.
– Lower your debt to income ratio. That means the bigger your income is as opposed to your debt, the higher your score will be.
– If there are missed payments, pay them off and stay current. Though past payment delinquencies affect your score, the consistent good payment behavior that you are currently displaying will have a sizable positive effect as well.
– If you cannot meet the minimum payment, contact your creditor and be honest about your situation. You can also get the aid of a debt relief expert to help out.
– Do not close off credit card accounts that you have paid off. It will reflect badly on your score.
– Do not open credit card accounts that you will not use. It is best to use all your card once in awhile and keep the balance low.
– Limit your inquiries on loans and credit accounts if you do not need them. These are reflected on your credit report.
– If you have to open accounts, spread them over a period of time. Do not open them simultaneously.
Remember that your credit report should be available to you so feel free to request for it. If you haven’t used your free report, you can download a report from any of the three credit bureaus once a year.
Ideal Credit Score Range
Each of the three credit bureaus have different credit score ranges – or at least one of them is different from the rest:
TransUnion: 300-850
Equifax: 300-850
Experian: 340-820
Each of these bureaus have different methods in calculating the scores they release. Because of this, it is possible for you to have varying scores when you get from all three at the same time. We do have reports that they are working on coming up with a standard way of computing things. In the meantime, a lot of lenders use the FICO score as basis for your loan approval – or whatever is applicable.
So what is considered to be a good or bad score?
Different sources will tell you various ranges to determine what a good credit score is or not. A good score for an auto loan may not be the same as a mortgage loan. Although, a score of 660, in general, is considered to be a score. 620 is perceived to be a bad score. Anything in between is not really bad but it does leave room for improvement. For a detailed description, here is a breakdown:
720-850: No risk borrower – This is the best score that you can possibly have. This means you are in great shape and can get the best deals out of any finance related transaction.
675-719: Very Low risk borrower – This is still a good score and can get you a good interest rate on any loan.
675-699: Low risk borrower – This range will still get you good deals from most loans.
620-674: Moderate risk borrower – While considered to be a good range this score will already get you a higher interest rate from some lenders.
560-619: High risk borrower – Qualification for a loan will already be difficult and you need to improve on your score – otherwise, you may suffer high interest rates on your loans.
500-559: Very High risk borrower – You need to improve your score before attempting to apply for a loan – otherwise you will either be turned away or given a very high interest rate for being a high risk borrower.
Bottom line of these ranges is to indicate to the lender your risk factor as a borrower. The lower the score, the higher your risk and the higher your interest rate will be. So if you want to take out a major loan in the future, you have to keep your credit score 720 or above.
What is the American Credit Score Stat
In 2012, the American population is starting to feel the rise from the recession and that is evident from the rising credit scores. It is not yet as good as the pre-recession scores but the improvement is quite evident. While that may also be a result from a more mature and responsible consumer spending, it still bodes well for the lending industry.
Based on the FICO® Lab Report, here are the credit score statistics of the Americans:
800-850: 18.3% – highest since October 2008
750-799: 19.4% – lowest since April 2009
700-749: 15.5% – lowest since 2005
550-699: 31.9% – highest since 2006
300-549: 14.9% – lowest since 2006
From the statistics that we have seen it is evident that the percentage increase of Americans in the higher 800 score means credit holders are taking care of their debts. This could imply that they are now able to pay for their debts on time and keep up with various financial obligations.
The increase in the 550-699 range may or may not be a concern because experts believe that the bloat could be the result of the percentage decrease of the Americans in the 300-549 range. People are getting out of the credit score slump – probably because a lot of lenders have agreed to a lot of debt settlement negotiations and thus have decreased the total debt of several borrowers.
One of the three major credit bureaus, Experian, conducted a study to determine which cities are the best credit score holders from January – June 2011. This study is based from the VantageScore data collected by Experian. It shows that the Midwest region of the country are the best credit holders. Based on the report extracted from their site, here are the top 5 cities with the best credit scores:
1. Wasau, WI: 789 – This city was not even included in the list last year but now, they hold the top spot.
2. Minneapolis, MN: 787 – Last year, this city ranked number 1 but was bumped off by Wasau. They still hold a good average in terms of credit scores though.
3. Madison, WI: 785 – Trailing behind is the city that ranked 2 last year. This is another city from the State of Wisconsin.
4. Cedar Rapids, IA: 781 – On the number 3 spot last year, this city slipped to number 4 but still has a good credit score to boast of.
5. San Francisco, CA: 781 – Having a credit score that is tied with the number 4 city, San Francisco is the only one who retained its spot last year.
Here are the bottom 5 cities with the lowest credit scores:
1. Harlingen, TX: 686
2. Jackson, MS: 701
3. Corpus Christi, TX: 702
4. Monroe, LA: 706
5. Shreveport, LA: 706
The average credit score for the Americans are quite high at 749 – but a lot of them still needs to recover as they are still under the risky borrower range.
Credit Score Before Buying a House
One of the biggest purchase that the average American will make is buying a home. It will cost you hundreds of thousands and most buyers resort to loans in order to afford one. Since you will be borrowing a big amount, you need to be able to prove that you can pay the lender back. This is where your credit score will help.
While it is not the only reference, it has a major influence on the loan approval because it tells of your payment behavior. It is not really about how much you earn but your diligence in paying off what you owe in the past.
More often than not, the ideal credit score before getting a mortgage is 720 and above. The principal amount is big enough so you need to avoid a high interest rate in order to cope. That means you have to be a low risk borrower.
If your credit score is between 650-700, you will still be approved of a loan but that may entail a higher interest rate. You might be able to negotiate with some lender though. But if you are below 650, you might find it hard to negotiate. Apart from the rates, you could be paying higher fees on your insurance and closing costs. To compensate for the risk, some lenders may require you to put up a higher down payment on the home you will be buying.
Credit scores that are as low as 500 will definitely have a problem getting an approval. It is best to postpone your home purchase plans until you have increased your score. The interest rate that you will be given with a this credit score may not be worth it.
Knowing your credit score is very important before applying for any loan – much more with a mortgage application. The lender will still consider your income to debt ratio, employment stability and savings before they decide but usually, a good credit will help speed up the process.
On Getting Free Credit Scores
It was a major issue before when consumers asked why they had to pay for a credit report when the data is rightfully theirs in the first place. Technically, you will be paying for the labor that it took to generate the report but still, the fees were not viewed as reasonable.
Although you can monitor your credit score for free by downloading your annual free credit report from the three major credit bureaus, it can lead to inaccuracies. It is doubtful that the average American completely understands how to compute their credit scores themselves.
Thankfully, there are businesses that offer this service for free. Here are the two sites that we can recommend that you use in order to monitor your credit scores for free.
CreditKarma.com
This site believes that it is a basic consumer right to be able to monitor one’s credit score. With this in mind, they offer this service so their member’s can access their credit score anytime. You only have to register with them. No credit card or commitments will be asked from you.
The company behind this site offset the costs of getting credit scores from the advertisement profits they get from the website. By becoming a member, you get access to the following benefits:
– Updated credit score anytime.
– Personalized debt management tips that will help you decide on the best savings option to pursue.
– Access to tools and calculators that will help monitor your score as you work on increasing it.
– Free platform to manage your finances and track your credit health.
CreditKarma guarantees that any information on the account that you will make will be protected. If anything, only your credit score will be shown to advertisers who have Karma Offers or promotions that the website feels is for your best interest. However, it is only limited to tagging you on offers based on your credit profile. CreditKarma does the filtering and tagging so no information escapes beyond their control. None of your personal information will be given to any third party – unless you have given permission for it to transpire.
CreditSesame.com
Another site that is worth checking out is CreditSesame. By providing your legal name and email address, you get to use their site to monitor your credit score and manage your finances for free. Here is a list of things that you can enjoy by becoming a member of their website.
– Tracking and monitoring tools that will keep you updated of your loans, credit accounts, debts and credit scores.
– Updates on the best offer from the lending market and major banks.
– Saving option recommendations based on your credit profile and income.
– Loan analysis tools so you know if you can afford to take out a loan with your current financial condition.
– Access to online loan applications with monitoring tools so you stay updated of the application status.
CreditSesame works by asking financial data from you – the typical information that is required by banks and other financial institutions. By using your debt to income ratio and credit score, they will analyze which among the thousands of financial offers from the lending market and major banks will suit your needs. The ultimate goal is to improve your credit standing by taking advantage of the market changes happening in the economy. They will provide you will recommendations that are unique to your financial and credit profile.
If security is a concern, this site is fully protected and approved by authority brands like Verisign and Experian. 128-bit SSL encryption protects every data transfer from the server to your browser. State of the art facilities protect the servers housing all sensitive financial data. No information will be released about you – unless it is with your full and voluntary consent.
NationalDebtRelief.com is here to help you achieve financial freedom through proper information and guidance. We have debt relief programs that you can avail – just give us a call.
National Debt Relief helps people nationwide resolve $10k or more in unsecured debt. Our debt coaches negotiate with creditors on your behalf so that you pay a fraction of what you owe and can become debt free in as little as 24-48 months.
