Your Credit Score

 

 

The term credit score usually refers to your FICO score, a number based on a formula developed by the Fair Isaac Corporation, which looks at a summary of all your credit accounts and payment history. Your FICO (credit) score determines your access to and cost of credit. Most lenders use it as the main basis for loan or credit approvals, so the higher the better and the lower the more problems. FICO score ranges from 300-850, and Fair Isaac calculates them for each of the three big credit-reporting agencies: Equifax, Experian and TransUnion.

Here’s how your score is determined:

  • 35% is determined by your payment history. Do you regularly pay your bills or fines on time to any creditor that submits your information to the credit bureau? Overdue medical bills, collections, and other liens may appear here.
  • 30% based on the amounts you owe each of your creditors, and how that compares with the total credit available to you or the total loan amount you took out (debt to equity ratio). If you’re maxing out your credit cards, your score may suffer.
  • 15% is based on the length of your credit history, both how long you’ve had each account and how long it’s been since you had any activity on those accounts. The fewer and older the accounts, the better (assuming you’ve made timely payments).
  • 10% is based on how many accounts you’ve recently opened compared with the total number of your accounts, as well as the number of recent inquiries on your report made by lenders to whom you’ve applied for credit. Your score can drop if it looks as if you’re seeking several new sources of credit — a sign that you may be in financial trouble. Every inquiry you trigger when you apply for a credit card, auto loan, or mortgage could affect your score. So be selective.
  • The final 10% is determined by the types of credit used. Having installment debt — like a mortgage, in which you pay a fixed amount each month — demonstrates that you can manage a large loan. But how you handle revolving debt, like credit cards, tends to carry more weight since it’s seen as more predictive of future behavior. (You can pay off the balance each month or just the minimum, for example, charge to the limit of your cards or rarely use them)

Rating Your Credit Score

For the best rates on a loan or credit card, you want a score that’s above 740. The median US credit score is 720 (half the population has more than this, while the other half is lower). The next section looks at how to achieve a good score, but here how the various FICO score ranges compare:

  • A score above 740 means you have excellent credit with an excellent history of paying back and managing debt. Even in this economy, banks will happily lend to folks with 740+ credit scores, meaning they will get the best rates and easiest access to credit.
  • FICO score from 700 to 740 is very good and above average. You may not get the best rates, but if you have a stable job and little debt then you should get a very competitive rate. However focus on getting to the 780 level, using the simple tips that follow
  • FICO credit score between 640 to 700, you have a little work to do. You won’t be denied loans on this score but the terms aren’t going to be too generous. You need to work hard to get your score into the higher ranges or face the prospect of years of rising debt payments.
  • Credit score below 640. Once upon time banks used to love sub-640 borrowers because they could charge them the highest rates and reap the biggest profits. This group were called the “sub-prime” borrowers. Then we had a crisis with the same name, and the rest is history. Now banks and brokers won’t give you the time of day. You really need to focus on repairing your credit (it can be done!) or learn to live without it.

You are likely to see improvement in your scores within 45 days if you pay down significant chunks of your credit card debt. But otherwise, credit repair takes time, and how much time depends on the many details of your credit reports. If you have serious issues, such as bankruptcies or foreclosures, you can see significant improvement in your scores as time passes. You may have to wait at least 2 years from discharge date on a Chapter 7 bankruptcy and 3 years from sheriff’s sale date on a foreclosure in order to obtain mortgage financing.

 

Improving or Repairing your FICO Credit Score

The good news is that no matter what your score you, can always do things to improve it. Some may seem counter-intuitive, but they are all looked upon favorably by the rating agencies:

  • Check the credit reports that you get with your FICO score for errors, omissions and potential identity theft. Omissions matter because you want to show that you have paid off loans. If you notice information that’s inaccurate, you can submit a request for removal by mail or online with the major rating agencies. Be sure to specify what information you think is inaccurate and why, and include any documents that support your argument. Ask in writing that the information be corrected or removed from your report. By law, the bureaus must investigate your complaint, usually within 30 days, and give you a response in writing (or via e-mail, if your request was made online) and a free copy of your report, if the information is changed as a result. Your score should reflect that change shortly after.
  • Paying your bills on time is crucial. Since 35% of your score is based on your payment history, delinquent payments and collections can have a severe impact on your score. If you can’t pay off your credit card debt every month, pay it down to less than half the maximum available balance.
  • A quick and effective way to improve your credit score in this area is by paying down your revolving credit. In fact, owing the same amount but having fewer open accounts may lower your score. So don’t cancel the credit card once you’ve paid it off because the score considers longevity and available (revolving) credit.
  • A common mistake for many frugal and debt averse individuals is never using a credit card. It is recommend that you get a credit card and use it more gas or groceries and pay it off each month.
  • Multiple inquiries on a credit report can result in lower credit scores.
  • Re-establish your credit history if you have had problems. Opening new accounts responsibly and paying them off on time will raise your credit score in the long term.