Understanding Credit Scores and Credit Reports

Love em’ or hate em’, our credit scores affect our lives.

Your credit score is a number that is calculated based on your credit history to help lenders identify the level of risk they may be taking if they lend to you. Scores range from 300-900. The actual formula for exactly how the score is calculated is proprietary information and owned by Fair Isaac (FICO).

Your credit report is historical information about how you pay your bills and repay loans, how much credit you have available, what your monthly debts are, and other types of information that can help a potential lender decide your credit worthiness.

Credit scores are reported by over 1000 credit bureaus across the country, but most are affiliated with the three large bureaus, Experian, TransUnion and Equifax.

Equifax – www.equifax.com

To order your report, call: 800-685-1111 or write: P.O. Box 740241, Atlanta, GA 30374-0241

Experian – www.experian.com

To order your report, call: 888-EXPERIAN (397-3742) or write: P.O. Box 2104, Allen, TX 75013

TransUnion – www.transunion.com

To order your report, call: 800-916-8800 or write: P.O. Box 1000, Chester, PA 19022

Our credit scores help determine how much we pay, or if we even qualify to buy, almost everything. They are used by our insurance companies, banks, even HOA associations and clubs to assess membership qualifications. Your credit score says a lot about you. It tells a story about what you have purchased and how you have handled your responsibilities in paying your debt. It’s definitely not a perfect system, but it’s not going anywhere so you better learn the system.

Your FICO is made up of ;

35% – An individual’s history of making credit payments on time

30% – The total amount of debt being carried along with available credit

15% – The age of an individual’s open credit lines (more history is better)

10% – The frequency with which someone applies for new credit

10% – Wild card factors such as the types of credit lines

Avoid these 4 pitfalls that lower your FICO score.

1. Late Payments – Late payments and your payment history are the largest single factor of your credit score. Paying bills consistently on time shows you take your debt seriously and that’s what lenders are looking for. Extra weight is placed on recent payment history.

2. Debt levels Too High– Don’t max-out or charge near the limit of your credit cards and equity lines. Carrying more than 25% balance hurts your score, and over 50% hurts it even more. Potential lenders want to see that you don’t spend all the money you have available to you.

3. Debt-to-Income Too High – Carrying too much debt for your income hurts your score. Typically lenders have their own calculations for figuring your debt-to-income ratio (some include mortgage payments, etc) and often lenders have their own standards for what interest rates to charge based on your score. Certain types of loans (signature loans, loans for luxury items) may require you to have a lower debt ratio.

4. Closing credit accounts– It may sound strange, but closing your credit card accounts can hurt your credit score, especially in the near future. Lenders look at your payment history and the history and duration of your accounts. Cancelling credit cards take away that history, and hurt your credit.

The higher your score, the lower your interest rate. Here, you can see the difference in interest you would pay with different scores. You can see that the difference between a score of 650 and 720 is about double the interest rate. To help understand the true effect your credit score can make, let’s use an example;

You buy a home with a loan amount of $300,000 (nice round number). If your credit score was good, say 730, you could expect to get an interest rate around 6.125% and have a payment of about $1822 (Principle and Interest). If your credit score was 640 you could expect an interest rate of around 6.65% for the same loan, resulting in a monthly payment of $1926.

You would be paying $104/month more simply because of your credit score. And let’s say you want a new car. Assuming a loan amount of $30,000 your 730 credit score could get you a monthly payment around $589, while that 640 score would result in a payment of $670, or $81 more/month.

Let’s say you keep the car and the house for 5 years and then sell them to move out of town. You would have lost $11,100 just by having that credit score difference. And that 90-point drop in your credit score (from 730 to 640) could be caused by something as simple as missing a couple mortgage payments (One 60-day late). Or activating two new credit cards with a $500 limit each and maxing them both out. That $1000 would have actually cost you 10 times the amount.

In the real world, your credit score and credit report can effect dozens of decisions over a five year period, resulting in a more significant difference than this example shows. Check your report a couple times each year to make sure it’s accurate. The $20 or so you’ll pay to check it could save you $thousands.

If you’re a student, a young adult, or just don’t have a credit score yet, there now some help. Fair Isaac now offers the FICO Expansion Score, which helps you raise your score a little faster.