Make The Most Of Your Credit Score Understand How Your Credit Score Works and How You Can Use Your Score to Your Financial Advantage
What s the Score? Put simply a credit score is a number used to predict your financial risk. Your credit score lets lenders and creditors know how likely (or unlikely) you are to pay a debt back based on your history of using credit. Credit analysts pull information from your credit report, account histories, and credit applications to assign you a score. Why Credit Scores are Important Credit scores are important if you plan on using credit at any time in your life. That s not just for credit cards either You need a good credit score to buy a new home or get a new car. In fact, you may not be able to rent a home or even a car without good credit. Your interest rates on any debt will be determined using your credit scores. Employers may look at your scores as part of the hiring process, so you could miss out on a job particularly in the finance, sales, and hospitality industries where you deal with financial transactions. Insurance companies may also consider your credit scores when deciding to issue, change, or renew your car insurance or homeowners insurance. Why Do I have More than One Score? You have more than one score, because different credit bureaus (also called consumer reporting agencies) calculate your score in different ways. You actually have numerous credit scores, but typically you only need to be concerned about the 3 credit 1
scores from the major credit bureaus Experian, Equifax, and TransUnion. Luckily, the three main credit bureaus all calculate scores using a similar method. All three are based on the credit score calculation from Fair, Issac & Company, Inc. For this reason, these scores are commonly called FICO credit scores. Happily, this keeps the three scores similar enough that making positive impacts on one score may also improve the other two (or at least not move them the opposite direction). Not only do you have different scores from the bureaus, different lenders will also use your scores in different ways. Lenders may calculate risk for their specific loan program, often using formulas that can change your credit scores from what you expect. The Tri-Merge Mortgage Assessment Mortgage lenders conduct tri-merge credit assessments, which mean they check your scores and your credit report with all 3 bureaus. If the scores vary, the lender typically uses the middle score to calculate your credit worthiness. What s in a Score? Although other scores use different calculations, any FICO credit score or variation of a FICO score will consider 5 factors, each with a weight for how much it affects your credit score. 1. Payment history 35% 2
2. 3. 4. 5. Total debt owed relative to your income 30% Length of credit history 15% New credit applications 10% Types of credit currently in use 10% The first two factors make up more than 2/3 of the weight in determining your score. This is an advantage to you as a consumer, because these are also the two factors you have the most control over if you want to improve your scores. If you pay off debt, you reduce your total debt owed and build a positive payment history at the same time. Length of credit history often skews scores for young people and anyone who s avoided using credit in the past. This can be a big disadvantage in buying a new home or car if you did what you thought was the responsible thing in avoiding using credit cards to make purchases in your daily life. New credit applications are assessed, because in some cases someone seeking multiple new lines of credit can be an indication they re experiencing financial difficulty. If you take out several credit cards and applied for several loans your credit scores can actually drop. Creditors also look at the types of credit you use. Different kinds of loans and credit can have negative or positive impacts on your scores. A mortgage is a positive loan to have on your credit report, particularly if you re current. A payday loan is often viewed negatively by credit reporting agencies and can even decrease some FICO scores slightly. Credit cards from major creditors are better than department store credit cards. 3
Finding Your Credit Scores Sometimes people assume they can get their credit scores by looking at their credit report, but these are really two different things. Your credit report is a factor in calculating your credit scores, but there s more to your scores than just your report. So, while you can receive a free credit report each year via annualcreditreport.com, it won t tell you your scores. To get your credit scores, you either need to purchase them from each credit bureau directly or you can use an online service that lets you purchase your report and scores as one package. Equifax Equifax Credit Information Services, Inc. P.O. Box 740241 Atlanta, GA 30374 1-888-766-0008 Website: www.equifax.com Experian National Consumer Assistance Center P.O. Box 2002 Allen, TX 75013 1-888-397-3742 Website: www.experian.com TransUnion, LLC Consumer Disclosure Center P.O. Box 1000 Chester, PA 19022 1-800-888-4213 Website: www.tuc.com 4
How Long Does Negative Information Hurt My Scores? Anything negative that appears on your credit report will negatively impact your credit scores as long as it s there. Here are the most common penalties you see on a credit report and how long they can legally be listed. Late payments 7 years Collection accounts & charge-offs 7 years Chapter 7 Bankruptcy 10 years Chapter 13 Bankruptcy 7 years Unpaid tax liens 15 years Paid tax liens 7 years It s important to note the impact of each of these decreases the more that time passes. So, if you have a bad past with credit, you can make positive moves for your credit now that can improve your score faster than you think. Leave Old Accounts Open If you see an account on your credit report that you thought you closed, realize your credit report usually continues to list these accounts to keep track of your total history. In fact, these old accounts improve your length of credit history, so having them removed can actually hurt your scores. 5
What Does a Bad Credit Score Cost? Bad credit scores can cost you quite a bit. Here s one example looking at a $20,000, 4-year auto loan: 1. Excellent credit score (700-800): o The average interest rate approval is 6.7% APR for excellent credit. o You would pay roughly $476 per month o Your total interest paid would be $2,855.01 2. Poor credit score (590-619): o The average interest rate approval is 13.5% APR for subprime credit. o You would pay roughly $542 per month o Your total interest paid would be $5,993.27 Having excellent credit saves you $66 per month on your monthly car payments and $3,138.26 in total interest paid! How to Use Credit Scores to Your Advantage Obviously the first step in using credit scores to your advantage is to make sure you have strong scores. Check your credit report and get your scores to see where you are. If your scores are lower than you want, take steps to rebuild your credit to get your scores to where they need to be. Once you have your credit scores in order, you should use them in the following ways: Refinance your home. The real estate collapse put many consumers in a position where they are tied up in mortgages that effectively overcharge them given current home values and interest rates. Lenders are more likely to negotiate with a consumer who has strong credit scores. 6
Refinance your car. Interest rates are at all-time lows which makes it the perfect time to refinance your car at a better interest rate. Negotiate to lower interest rates on your credit cards. Creditors are more likely to negotiate to lower the interest rates on your credit cards if you have strong credit scores. Get new lines of credit with better interest rates. If you can t get your creditors to lower your rates, use your good credit scores to get new lines of credit possibly even a card with a 0% balance transfer APR, so you can consolidate debts from high Always check your credit report and credit scores at least 3 months before you make any big purchase or apply for a new line of credit. This gives you time to correct any mistakes so you don t get penalized for a credit report discrepancy. 5
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