What is Your Credit Score? Your credit score is a three-digit number that’s meant to reflect your credit and payment history and summarize your creditworthiness to potential lenders. In the new information-based economy, it’s one example of how information about you is collected and analyzed. Prospective lenders purchase the information to help them make profitable decisions about whom to lend to, and under what terms. People with a higher score are considered good credit risks and will be offered the most favorable terms for loans. Those with lower scores are considered less credit-worthy, and will be offered loans with higher interest rates and more restrictive terms generally, and there may be other consequences as well: A higher down payment may be required. Interest-only options may not be available. The size of the loan offered may be limited. An applicant may not be able to qualify for a loan at all. Insurers may also increase your premiums based on a low credit score. Prospective employers may regard a low score as a sign of poor discipline. Your credit score shapes your financial life in profound ways, so it’s important to understand how it’s generated, how to monitor your credit report effectively and how to recognize problems and effect repairs when necessary. First, a few definitions: FICO: FICO is an acronym for Fair Isaac Corporation and refers to the bestknown credit score model in the United States. The FICO score is calculated by applying statistical methods, developed by Fair Isaac, to information in your credit history. The FICO score is primarily used in the consumer banking and credit industries. Credit reporting agencies: Equifax, Experian and TransUnion are the primary US credit reporting agencies. They calculate their own credit scores based on information within their files. These scores tend to be mathematically scaled so that they fall in the same general range as the FICO score, but they are not identical. Credit report: Because the government has recognized that incorrect information in your credit history can have an enormous negative impact on you, the law now requires each of the three major credit reporting agencies to provide you with a free copy of your credit report once per year (website follows). Note that this
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does NOT include your credit score, which lenders must pay for. If a lender does run a credit report on you, you should always request and review a copy of the report, which will include a score. You should review your credit report at least twice per year. If you notice any incorrect information, you must contest it in writing with each credit reporting agency where it appears. They are required to include your request and any explanation of disputed accounts in your file.
Your Credit Score and Your Money Credit scores range from 300 to 850. A score of 720 is considered outstanding; 680 is pretty good. When your score dips to 620, lenders will question your credit worthiness. To translate credit scores into monetary terms, let’s look at a mortgage: Assume that you wish to borrow $300,000 at a 30-year-fixed rate in California. With a credit score of between 680 and 850, you will qualify for a 5.93% rate and a monthly payment of $1,785. If your credit score is between 500 and 579, you will have a loan that is at 8.825% rate with a monthly payment of $2,376. The difference means $591 less in your pocket each month for the next 30 years, or a total of $212,800 over the life of the loan. Components of Credit Score Although the exact formulas for calculating credit scores is proprietary information, we know the components and the approximate weighted contribution of each:
35% Punctuality of payment in the past: This is the biggest component, so it’s important to pay bills on time! If items go to collection, the impact on your credit score is as negative as a bankruptcy. The most recent 24 months has the greatest impact, so maintain good credit practices, and the score will improve with time. 30% Amount of debt: This is expressed as the ratio of current revolving debt (credit card balances, etc.) to total available credit (credit limits). It is best to keep it low: 10% is ideal; over 50% is too much. Although you may want to keep fewer credit cards to minimize administration work, it’s best not to close too many accounts at once, as it will reduce available credit and thus increase the ratio. 15% Length of credit history: Creditors need to know your payment behaviors over a number of years. If you are applying for credit, it’s best to keep old accounts open and use them occasionally to improve your score. 10% Types of credit used: Variety is optimal, such as an auto loan, a mortgage and a few revolving credit accounts. 10% Number of inquiries over the past six months: “Hard inquiries” are from credit providers to whom you have given your consent to run a credit report. These can reduce your score by 2 to 50 points. If you already have credit problems, the reduction will be higher because of a presumption that you shouldn’t be asking for more credit. If you are shopping for a mortgage, it’s understood that many inquiries may be made on your behalf, so several hard inquiries in a two-week period will be counted as one. Soft inquiries are unauthorized inquiries for credit solicitations; these don’t count against you.
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Taking Charge of Your Credit Score It’s a fact of modern life that personal information about you is collected, analyzed and sold, and that errors in your credit report can cause you financial harm. Therefore it’s crucial to monitor your credit report regularly and challenge any incorrect information, promptly and in writing. You should review your report at least twice each year; more often if you have reason to suspect you may be a target for identity thieves, for example if your wallet, purse or mail was stolen or lost. If you suspect that someone has appropriated your personal information, name or social security number, take action by freezing your credit file and filing a police report. Below are some resources to assist you in monitoring your credit report and taking action in case of identity theft. For further information, check our article on Identity Theft at WalesInvesments.com in the Client Area.
Resources Credit bureaus: Equifax Experian TransUnion call 800-525-6285 888-397-3742 800-680-7289 877-322-8228 or go to www.annualcreditreport.com
Free credit report:
Online resources www.consumer.gov/idtheft FTC site with affidavit note: scroll to the bottom of this page to download the FTC publication: Take Charge: Fighting Back Against Identity Theft www.privacy.ca.gov www.idtheftcenter.org www.privacyrights.org Tells how to freeze your credit report Identity Theft Resource Center Privacy Rights Clearinghouse
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