Understanding Your Credit Score

Transcription

1 Understanding Your Credit Score

2 Whether or not you re aware of it, your credit score (or lack thereof) plays a significant role in your financial well being. Build a great score and you ll enjoy the rewards that come with it. But let it slip, and you may be punished by it for years. Despite their significance, credit scores remain a mystery to most, but they don t have to be. What s a credit score? Simply put, a credit score is a numeric measure of how well you ve managed your credit obligations (debt) over time. It was designed for use in loan decisions, but it now has implications in many areas, including: Insurance (Auto, Home, Life, etc.) Your credit score may be a factor in the calculation of your insurance premium. Utilities (Gas, Water, Electricity, Cellular, etc.) Without a good credit score, you may be subject to a higher security deposit, which will need to be paid prior to getting your utilities connected. Employment Many employers now incorporate your credit score or profile to determine your eligibility for employment. Special Financing Offers Without a good credit score, you will not likely be able to qualify for special offers such as no interest/no payments until that you see advertised on television. There are hundreds of variations or types of credit scores, which doesn t make understanding them any easier. But all credit score calculations award points for good behavior, and subtract points for bad behavior so the higher the score, the better. For the sake of example, we ll examine the most widely used credit score type in the United States the FICO score. What s a FICO score? Although the exact formula for calculating the FICO score is secret, Fair Isaac (the developer of the FICO score) has disclosed the following components and the weight of their impact to the score: Payment History 35% Late payments on bills, such as a mortgage, credit card or automobile loan, will cause your FICO score to drop. The more late payments, and the longer they are past due (30, 60, 90 days), the more your score will suffer. Conversely, bills paid on time will improve your FICO score.

3 How a FICO Score breaks down 35% Payment History 30% Amounts Owed vs. Credit Available 15% Length of Credit 10% New Credit 10% Types of Credit Used Different Types of Credit: 15% LENGTH OF CREDIT 30% AMOUNTS OWED VS CREDIT AVAILABLE 10% NEW CREDIT 35% PAYMENT HISTORY 10% TYPES OF CREDIT USED Non-Revolving Credit - This is also known as an installment agreement. This type of account requires you to pay a fixed monthly amount (or more), until the principal is paid off in full at which point the account is closed. Mortgage, auto and student loans are examples of non-revolving credit lines. Revolving Credit - Monthly payments on revolving lines of credit, such as credit and department store cards. Payments fluctuate based on how much credit you have used and how much you choose to pay off each month. Secured Credit - Refers to loans secured by an asset, such as your home or car. Unsecured Credit - Unsecured credit does not involve collateral. This type of debt typically refers to credit and retail cards. Amounts Owed vs. Credit Available 30% Keeping a low ratio of current revolving debt (such as credit card balances) to your total available revolving credit or credit limit will increase your score. For example, if you have a combined credit card limit of $10,000 and you have only $2,000 in balances that s a credit utilization ratio of 20%, and would be considered a good and reasonable ratio. By contrast, if you have a combined credit card limit of $10,000 and you have $9,500 in balances that s a credit utilization ratio of 95%, and your score would be negatively impacted by it. The most obvious way to improve this aspect of your FICO score is by paying off debt and lowering your credit utilization ratio. Alternatively, receiving a credit limit increase may also drive down your utilization ratio (in the example shown above, if your limit was raised to $15,000 your utilization ratio would drop in both scenarios, demonstrating that you use revolving credit reasonably). Many experts believe a 20-30% credit utilization ratio is best. While opening new lines of credit may have a positive overall effect, opening too many have a negative impact. The closing of existing revolving accounts will typically adversely affect this ratio and therefore have a negative impact on a FICO score. This is a common mistake that many people who are trying to improve their score make. Even worse, if it is an old account being closed, you will be reducing your length of credit.

4 Length of Credit 15% As your credit history ages it can have a positive impact on your FICO score. A credit card that you have used reasonably for many years, or a car loan that you ve demonstrated on-time payments with for several years will make a positive impact. If all of your credit is newer, it is not seasoned enough to make a positive impact since you haven t yet demonstrated a history of on-time payments and/or reasonable utilization. Your FICO score will likely increase as the average age of your credit increases. New Credit 10% Hard credit inquiries, which occur when you apply for a credit card or loan (revolving or otherwise), can hurt your score, especially if done in great numbers; often three to five points per inquiry. If you re rate shopping for a mortgage or auto loan over a short period you ll not likely experience a large decrease in your score as a result of these types of inquiries. Automated computer algorithms attempt to detect when you re rate shopping (and not attempting to receive many new lines of credit), and they treat all of those hard inquiries as one. While all credit inquiries are recorded and displayed on your personal credit reports for two years, their impact decreases at the six-month and one-year mark, rendering them insignificant after a year. Credit inquiries originated by you (such as pulling a credit report for personal use), an employer (for employee verification) or by companies initiating prescreened offers of credit or insurance do not have any impact on a credit score. These are called soft inquiries or soft pulls, and do not appear on a credit report used by lenders. Types of Credit Used 10% You can benefit from having a history of managing different types of credit - installment, revolving, consumer finance, mortgage, etc. A diverse credit history (with on-time payments) shows that you can manage different types of obligations responsibly. What does my score tell someone about me? Simply put, your score tells a lender or other service provider what kind of a risk they are taking by lending money or extending services to you. When your score is high, it can be assumed by a lender that you are a low-risk borrower. You have paid your loans satisfactorily in the past and your current loans and lines of credit are being managed responsibly; there is no reason to think that the trend will not continue. As a result, you can expect higher dollar loans at lower interest rates. When your score is low, a lender may see you as a higher risk because you maintain higher balances on your credit lines, you have made late payments in the past, or you have failed to adhere to contractual guidelines on previous loans. As a result, you can expect to be offered a lower amount at a higher interest rate. And, you will not likely qualify for the best rates or terms you see advertised.

5 How can I ensure that I always get the best rates and deals possible? A few tips to maintain good credit or improve your score: 1. Always make on-time payments to current loans and credit card balances. Consider setting up automatic payments using Bill Pay, or by providing your credit card or debit card number to service providers who bill you on an ongoing basis. 2. Reduce the amount of debt you owe. You can pay your debt down more quickly if it is at the lowest interest rates available. If you already have a strong score, determine whether or not there are any opportunities for you to refinance some debt at a lower interest rate. 3. Try to maintain a good ratio of the amount borrowed versus the limit on revolving credit lines. When the percentage of amount owed is 70% or higher, lenders may see you as using your revolving lines as an extension of your income or not living within your means. 4. Do not apply for credit too often. Several inquiries in a short period of time can lower your credit score. Be aware of soft pulls and hard pulls on your credit and do not be afraid to ask the person conducting the credit review how this will affect you. 5. Have a variety of credit included in your profile. How often should I check my credit score or credit report? To maintain an ongoing knowledge of your credit report and score, you should review both on at least an annual basis, and as often as quarterly. And once you understand how the score works, you should not be surprised by yours. If you are, take a closer look at your credit report to ensure that it s accurate and that it doesn t include erroneous information. According to a recent study completed by the Federal Trade Commission, as many as 5% of us have an error on our credit reports that is significant enough to be of financial impact. As an Arizona Federal member, you can access your credit report and score online anytime with IDProtect, a comprehensive identity theft protection service that s included (at no additional charge) as a benefit of membership.

6 Confused? Overwhelmed? Don t be! Stop by any ServUs Center location or call us at (602) to make an appointment for a complimentary credit consultation. A Financial Expert will review your credit report and score with you and help identify actions you can take to improve your score. Have you set up your protection? Identity protection comes with your membership. While at any ServUs Center location, ask a Financial Expert to help you set up and use IDProtect. Or, call us at (602) and we ll be happy to walk you through it over the phone or set up an appointment for you at one of our locations. IDProtect is just one of the many services included in your membership. ArizonaFederal.org (602)