Your Credit Score Perhaps you’re ready to apply for the home equity loan for your dream kitchen or to visit the automobile dealership to discuss financing for a new hybrid car. Then a friend mentions that you should review your credit score before you go. Are they right? While learning your credit score can be useful, there’s no guarantee that knowing it will help you get better interest rates on your loans. However, you should know how your credit score is calculated and how it can impact several areas of your life.
A credit score is a measure of your creditworthiness—the statistical likelihood that you’ll pay back money that you have borrowed. Often referred to as a FICO score, it is named for the Fair Isaac Corporation, which developed the mathematical equation used to calculate a credit score from the information contained in your credit report. Each person has three different credit scores, one from each credit-reporting agency (Experian, Equifax and TransUnion). The higher the score, the better the loan rate you are likely to receive. Credit scores range from 300 to 850, but they are not static. They change as lenders funnel information to the credit reporting agencies. If you apply for several credit cards or loans in a short time, for example, it will lower your score, since inquiries about your credit are seen as warning signs by lenders. If you want to see your credit score, you’ll have to pay for it. The Fair Credit Reporting Act gave consumers the right to one free copy of their credit reports each year, but there’s no such provision for receiving credit scores. It will cost you about $15 to obtain it at the websites of FICO or the credit agencies. However, just knowing your score isn’t enough, says Chris Lambros, president of Green Pastures Mortgage and Finance Co. of Lutherville, Md. When you’re looking for a loan, “you need to talk to somebody who really understands what the scores mean, so they can help identify what needs to be done to improve your score” What about the offers that various organizations make to provide monthly credit score monitoring—for a fee? Forget it, advises Lambros. “I’m really against paying a credit card company $10 a month so you can see what your credit score is. Most of the time it doesn’t matter to you.”
Although the exact equation used to calculate FICO scores is a closely guarded secret, Fair Isaac reports that there are five general categories in credit reports that they consider in determining FICO scores.
On time and late payments to credit card companies, retail merchants, installment and mortgage loans.
Problem areas such as bankruptcies, liens or unsettled debts. The number of accounts you have and how much you owe on each.
What you owe in comparison to the total amount of credit available to you. How long you’ve had and used credit responsibly. The number of new credit card accounts or loans you’ve applied for or received. Your mix of credit accounts — retail, credit card, mortgage, and installment loans. Lenders look at your credit score every time you apply for a loan. But a good credit score doesn’t automatically qualify you for a loan, says Lambros. “While it’s important to have a decent credit score, its importance depends on the type of loan you’re looking for. In qualifying for a conventional Fannie Mae loan, for example, the overall credit history comes into play more than the actual credit score. People with a very respectable score of 690 or higher may not get a loan if the lender believes their debt ratio is too high," he adds.
It’s not only lenders who are using credit scores today. Utility companies may check them before providing service. Landlords will view them before deciding whether or not to rent to you. Businesses will examine the scores of job applicants to see if they are financially responsible and thus more likely to be responsible employees. (However, prospective employers cannot get this information without your permission.)
Even insurance companies pull credit scores on applicants. In Maryland, insurers can use your credit score to help determine what rates you will pay for your auto insurance. In some other states, they can use them as a factor in setting the rates for homeowners’ policies. “Insurance companies have found that credit scores are very indicative of the experience they’ll have with their clients—a better indication even than tickets or accidents,” says Craig English, PSA’s senior vice president and director of the property and casualty insurance division. If you’re thinking of making a major purchase such as a house or automobile, you may want to review your credit score to see if it is within the range that you’d expect. If it’s lower than you think it should be, there are steps you can take to raise it:
Check your credit reports for errors and insist that the credit reporting agencies remove them.
Information from someone with a similar name may be showing up on your report. A judgment or lien that you have paid may still be reported as open. You’ll need to find and present proof to the credit reporting bureaus to get such mistakes removed. Pay your bills on time.
If you’re behind, catch up. A consistent record of on-time payments raises your score. Keep your ratio of debt to available credit low. “The amount of debt you have makes a difference in your score, but what makes the biggest difference is your balance to high credit limit,” explains Lambros. “If you have a credit card with a $6,000 limit and you’ve charged $5,000, you’re not a good credit risk because you’ve used up most of the credit available to you. If you have a $5,000 balance on a card with a $20,000 limit, you’re a good credit risk because the majority of your credit is still available to you. Keep credit cards and credit accounts open even if you’ve paid them off.
“If you refinance or do a debt consolidation and pay off your credit cards, don’t cancel them,” says Lambros. “If you do, you’re telling the analysis that you had credit, ran it up too high and paid it off, but now you don’t feel responsible enough to keep it open. That can bring your score down drastically.” Although there is no guarantee, following these steps over the course of several months could raise your credit score by 20 points or more. Keeping your credit score as high as possible is important because it can impact so many aspects of your life. Being a responsible borrower can give you access to better interest and insurance rates, job opportunities and even living quarters, and could leave more money in your pocket at the end of each month. | 