Understanding Your Credit Score and How to Improve It!

Understanding Your Credit Score & How To Improve It

By Brendan Hamel, 9 yrs with Equifax and TransUnion

Do you know your credit score is?  Understanding your credit score and what it means can mean the difference between getting a mortgage or not, or a getting higher interest rate than you deserve.  While credit scoring is not new, it has only relatively recently been made available to the public. Fair Isaac Corporation or FICO, developed the statistical model most commonly used by lenders (over 90% of the largest banks in the US), which works in conjunction with credit information contained within the databases of the three national credit reporting companies;Equifax, TransUnion and Experian. A consumer’s score will range from 300 to 850, with the higher the score, the better (or less risky the consumer).  The FICO score is a quick, unbiased, consistent way for an underwriter to make a reasonably sound assessment on how likely you are to become delinquent on your loan, credit card or auto loan, etc....  Scores will vary among the credit bureaus due to the sometimes differing information within those files; however the FICO formula for producing those score is the same among all three bureaus. 

Here are the components and how a FICO score is determined:

• 35 percent Payment History: Having a long history of making payments on time and no missed payments on all credit accounts is one of the most important items lenders look for.
• 30 percent Amount Owed: This measures the amount you owe relative to the total amount of credit available. Someone closer to maxing out all their credit limits is deemed to be a higher risk of late payments in the future and this can lower their credit score.
• 15 percent Length of Credit History: In general, a credit report containing a list of accounts opened for a long time will help your credit score. The score considers your oldest account and the average age of all accounts.
• 10 percent New Credit: Opening several new credit accounts in a short period of time can lower your credit score. Also multiple credit report inquiries can represent a greater risk, but this does NOT include any requests made by you, an employer or by a lender who does so when sending you an unsolicited, "pre-approved" credit offer. Also, to compensate for rate shopping, the score counts multiple inquiries in any 14-day period as just one inquiry.
• 10 percent Types of Credit in Use: Your mix of credit cards, retail accounts, finance company loans and mortgage loans is considered.

Now that you know what is factored into a FICO score, and the importance placed on those factors, you can imagine how a consumer could affect his/her score.  Although you can't raise your score overnight, you can do so fairly quickly. The scoring formula gives more weight to recent activity. So, even six months of "good behavior" will have an impact, demonstrating that you are becoming a better risk.  Remember, the FICO score is trying to predict the likelihood of delinquency within the next two years, relying heavily on the last two years of credit history.  While there are things you cannot change that affect your credit score (age of your credit history or the history itself) there are positive steps a consumer can take to improve his/her score.  Here are some tips:

Pay bills on time.  Because payment history comprises the largest part of your FICO score, paying bills and on time is obviously going to have the largest positive impact.  However, the fastest way to improve your score is to pay down balances. This lowers the amount of credit you're using relative to how much credit you have available to you. Remember, FICO scores reward people who use a smaller percentage of their available credit. A good rule of thumb is using less than 50 percent of your limit on any card, or total available limit.

Avoid opening a lot of new accounts at once - this makes lenders uneasy - particularly if you don't have a long credit history. Many recommend not having more than five credit cards. If you decide to close some credit accounts, close the newer accounts first. However, don't close more accounts than necessary because this lowers your ratio of debt to available credit.

Rotate and use all of your cards - a dormant credit account will not help your score. If you do have a late payment, it's worth a call to the lender to see if they will remove this information from your records in a "goodwill adjustment." You can choose to dispute the late payment report. While it's in dispute, the item will stay on your credit report but not factor into your FICO score.  Also, be sure to dispute items in your credit file that are inaccurate.  If the items you’ve disputed cannot be verified by the company that reported it within 30 days, the derogatory information will de deleted from your file, resulting in a positive score change for you.

While there's no question that having a good credit score is essential, it's also important to point out that FICO scores do not take your age, sex, race, income, assets or employment history into account.  Capital (your money) and Capacity (ability to pay) are also determining factors in the loan process, along with credit (scores). 

It is important to know your score and how lenders view you.  What’s a good score? It depends on the lender and what you are applying for.  Generally, a score above 700 is considered a “good” score and anything above a 720 is thought of as very good to excellent credit.  Lower interest rates are given to the consumers with higher scores, as they are less likely to become delinquent on their loans.  Can you negotiate better interest rates if you know your score?  Absolutely.  You shouldn’t accept B-paper interest rates if you know you can qualify for A-paper rates.  Would you take advantage of “same as cash” or “zero-percent financing” if you knew your score would qualify you?  More than likely, you would.  Remember, knowledge is power.  Arm yourself with the knowledge of your credit score and how it can work for you.  For more information on understanding your credit score, visit www.myfico.com .  For information on obtaining your credit reports, visit www.equifax.com , www.experian.com , and www.transunion.com .