A credit score—often called a FICO score—is measure meant to reflect a person’s overall ability to pay their bills.  In other words, it speaks volumes about an individual’s financial health.  Checking your score is similar to getting your cholesterol checked.  You want the numbers to fall within a certain range, and if they don’t you need to take corrective action.  Failing that, you should expect to suffer some significant problems down the road.

 

It Matters

Why is your credit score so important?  Your score impacts you in several ways—some obvious and some not.  For example, when you go to take out a loan at a bank, the bank will check both your credit history and/or credit score.  In a way, your score gives the bank a quick read on your financial health.  That makes it easier to make a snap decision on your credit worthiness.   A score will also impact the rate charged on your loan.  If you have a good score, the bank will give you a good interest rate.  And if your score is poor, you may pay a high rate or not qualify for the loan.

 

Hidden Impacts

How else does your score impact you?  Many insurance companies check your credit score when they underwrite your policy.  A good score can reduce the premiums on your car  or property.  Whether this is fair is beside the point, since some companies have determined that those who pay bills on time tend to be suffer fewer losses.

 

If you go to rent an apartment, a credit score can also determine whether you get to rent or not.  Landlords want to be assured of payments, right?  The same holds true for cell phone providers—they want customers who pay their bills on time.

 

Also, your potential employer may check your score to glean information about the type of person you are—the assumption is that those who pay on time are more responsible and will probably show up for work.  This may seem unfair, especially for those who are in the most need, but more and more employers are looking at credit history and credit score as they go to make hiring decisions.

 

Taking Steps

Knowing that a poor credit score can result in paying significantly more for goods and services, or that it may prevent you from getting a job, should be enough motivation to figure out how to improve it.  But where do you start?

 

Credit History

First, it pays to understand exactly how a score comes about.  Your score is a number that is determined by your unique credit history.  Your history comes about over time as you buy goods and services on credit.  The more you borrow, and how or whether you pay it back on time, are all part of the equation.

 

Credit history is recorded by three national credit bureaus. The three firms are Experian, TransUnion and Equifax. Though the rules to create a credit score can seem arbitrary and complex, the are really nothing more than a means to interpret and evaluate your credit history and will fall in a range from 300 to 850.  In this case, 300 is considered poor and 850 is considered outstanding.  The median average score is about 723, according to FICO, which is the company that developed credit scoring.  We should point out that a FICO score is like a snapshot of your credit history—that means it will change from time to time depending on your use of credit.

 

More On Scores

If you don’t know your credit score you can find out exactly what it is for free at MyFico.com. If you discover your score is above 760 you are generally considered to be a good credit risk.  However, if your score is just barely at this level or lower you may want to take steps to improve it. MyFico.com provides a good example on their homepage why a better score is important.  According to the website you could,

 

Save $139/month with a FICO score of 740 compared to a 620 Score on a $20,000, 48 month auto loan. That’s a savings of $6,672 over the life of the loan.

 

Building A Score

What many people find surprising is improving a score is not just a matter of paying bills on time—though that definitely helps.  The following list is designed to explain how certain action you take affects your score:

 

(1) Repeated Late Payments:  Making payments late month after month will severely impact your credit score.  In fact, your payment history accounts for 35 percent of your overall score.  That’s a huge chunk.  If you multiple 850 by 35 percent it’s nearly 300 points out of the total.  If you want to make the biggest impact to clean up your score, pay all your bills on time.  Even two or three missed payments within a single year could reduce your score by up to 200 points.

 

(2) Credit Approaching or Over The Limit: You don’t even have to go over your credit limit to negatively impact your score, though going over is worse.  Your score can go down by 100 points if your debt is consistently too close to your account limit. For a better score, use no more than 10% of your total or individual credit limit at any one time.  That means, if your limit is $1000, you should go no farther than $100 in debt.

 

(3) Hard Inquiries To Open Accounts: Whenever you apply for credit—for example, apply for a new credit card or bank loan—the bank or company you’re dealing with will make an “inquiry” to determine your credit history.  This is a considered a hard inquiry and can cost you up to 40 points if occurs too frequently.  Though there is some leeway granted in this area, you can  limit the impact of hard inquiries on your score by managing your credit carefully.  In other words, switch cards or accounts infrequently.

 

A credit score of 760 is generally considered good.

(4) Closing Credit Card Accounts: You’d think closing a credit card account would be considered a good thing when it comes to paying off your debt.  However, it is important to understand that each account you have affects your overall credit limit.

 

Think of it this way:  Suppose you have a several credit cards—Card A through D.  Let’s say overall your credit limit among all four cards is $10,000.  By closing B, which has a $2000 credit limit you reduce the overall amount you can borrow to $8000.  Thus, if you are $1000 in debt, your new debt to credit limit ratio would be $1000/$8000 or 12.5%.  Remember when we mentioned the 10% rule above?  Closing card B took the ratio from 10% to 12.5% and thus to a point where it impacts your credit score.  The only solution here would be keep Card B open or reduce individual and overall debt to get it back under the 10% limit—in this case 10% of $8000 is $800 so that’s the total debt you should borrow if you intend to close Card B.  Otherwise, it can negatively impact your score up to 100 points, depending on how much it changes your debt to credit limit ratio.

 

(5) Shopping For Loans: Let’s say you need a home mortgage or car loan, and are talking to several different companies to compare rates. In a case like this, FICO won’t ding you on your score as long as credit inquiries are all made within a 45 day period. In other words, you should get a break on the hard inquiry rule as long as all your inquiries fall within the allotted time frame.

 

(6) Soft Inquiries: Unlike hard inquiries which deal with loans, soft inquiries relate to credit where no lending is involved.  An example might be a phone or electric company—either of which may extend limited credit but not as an actual loan.  Soft inquiries won’t hurt your score.

 

For more information on what goes into to building your credit score, see this page at MyFico.com.  Or for tips on improving your score check this one.

 

Worth Finding Out

Do you know your credit score?  If you don’t, it may be costing you a lot more than you think.  And here’s a final note: Once a year you are entitled to receive a free credit report from the 3 national credit bureaus listed above. For your convenience these companies have jointly set up a website called AnnualCreditReport.com to handle these requests.  Check the site for more information.   A credit report is simply a summary of your credit history, and as we’ve learned, it is used to calculate your credit score.  That makes checking your credit report regularly worth your time and effort as these companies do make mistakes.  Mistakes come about for a variety of reasons, but can include clerical errors or confusion among common names.  If you find an error, be sure to challenge it.

 

Sources:

Wikipedia,  MyFico.com, Bankrate.com, Federal Trade Commission, AnnualCreditReport.com

 

By Bob Anderson
© Javabird LLC.  All rights Reserved.

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