Credit Score

Credit Score

Your credit score is a number (usually 300 to 850) that you can think of as your financial reputation. Actually, you have three different credit scores at any time—one from each of the three credit bureaus, or reporting agencies: Experian, Equifax, and TransUnion.

THE DEFINITION
A three-digit value calculated by the credit bureaus, which applies various weighting toward factors that predict future debt-repayment behavior. Factors such as employment, income, credit lines outstanding, debt-to-income ratio, past payment behavior, factor in to a person’s credit score (also known as a FICO score). –NASDAQ.com

SMART MOVE

Freddie Mac suggests you limit your number of credit cards and pay the balances in full every month. Using them responsibly can help you build excellent credit.

The Benefits

Maintaining a high credit score, or “FICO score,” tells the world you’re responsible with money and can be trusted. This will be extremely valuable when you apply for a home mortgage or car loan, try to rent an apartment, or sometimes even when you’re applying for a job. Having a strong credit score means you can receive more favorable terms when you borrow money than people with poor credit scores can. It can also mean the difference between whether or not you qualify for a loan in the first place.

FAST FACT

Credit scores are often used in determining prices for auto and homeowner’s insurance.

The Dangers

Mismanaging your finances can shave a lot of points off your credit score. A low credit score sends its own a signal to the world—that you’re unreliable with your financial obligations and therefore a higher risk for all the things we mentioned above, like loans, an apartment or even a job.

One other danger to keep in mind is that mistakes can be made to your credit history, and those mistakes can affect your credit score. Sometimes a company you’ve done business with, like your phone company, might have incorrectly reported that you paid a bill late. Or sometimes you’ll find your credit history mixed in with someone who has the same name.

It’s smart to check your credit report—which includes your credit score and all the details that go into reaching that number—at least once a year, so you can spot any mistakes and correct them.

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How is this a tool?

If your credit score is just a number, then why do we call it tool in Your Money Kit? Because you own it. Like a checking account or credit card, your credit score is a financial tool that you control through your behavior, and that if you use wisely can open up great opportunities for you—like the most favorable loans out there.

And like your other money tools, if you mistreat your credit score, it can become a weight on you that financially drags you down, just like debt can.

FAST FACT

The FACT Act (Fair and Accurate Credit Transactions Act), entitles each US resident to a free copy of her credit report from each agency once every twelve months.

What’s a great credit score?

Anything above 800 is outstanding—and pretty rare. The high 700s are considered great scores by most lenders. And a 720 will get you the best terms on a loan, according to Fair Isaac Corporation (the credit-scoring company from which we get the name FICO score).

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What goes into your credit score?

The credit bureaus all keep the precise details of their formulas secret, so no one knows exactly how these bureaus calculate each person’s unique credit score.

But thanks to CardRatings.com, we have a pretty good breakdown of the key factors the credit bureaus look at to determine whether your credit history is worthy of an excellent, good, average or poor credit score. There are five key factors:

  • Timely payments
  • Debt-to-available-credit ratio
  • Length of your credit history
  • Credit Mix
  • Recently added credit

Let’s talk about each of these.

Timely payments—35% of your score

By far, the credit bureaus are most concerned with how reliably you pay your bills. This one behavior—whether you make your payments on time—counts for over a third of your whole credit score.

This includes all your payments—your rent, mortgage, student loan, cable TV bill, credit card bills, your gardener’s bill or your plumber’s bill. If you fail to pay any one of these businesses the money you owe them, after 30 days they have the right to report your late payment to all of the credit bureaus.

And a single late payment can seriously drop your credit score.

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Debt to credit—30% of your score

The next largest factor is the ratio of money you owe at a given time to your total available credit limit. For example, if you have a $1,000 credit card balance (the amount you haven’t yet paid back) and a total credit limit of $10,000, your ratio is 10%.

That’s the ideal percentage, by the way. You always want to keep this low to maintain a good credit score—10% is best, but you can push it to 20%.

QUOTABLE

An investment in knowledge always pays the best interest. -Benjamin Franklin

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Credit history length—15% of your score

Your credit score goes up over time, if you maintain good financial habits. When you’re young and just starting to establish credit, there’s not much you can do to boost your score right away. Just behave responsibly, pay your bills on time, and your score will go up and up. One important strategy here is to keep your credit cards active for the long term—don’t cancel your cards. That’s because the longer you have each card open and active, the more responsible you look.

FAST FACT

Your credit report includes a list of debts and a history of how you’ve paid them, including credit cards, car loans and student loans.

Credit mix—10% of your score

This is a measure of the types of credit you have—mortgages, credit card debt, a car loan, a small business loan, whatever. Over time, you’ll use other types of credit in your mix, such as a mortgage loan—which is considered better because it’s secured debt, backed by a home. A credit card, by contrast, is unsecured debt because it’s not tied to any asset (like a house or car) that a creditor can seize if the borrower fails to pay back the loan. For now, though, you’re probably going to have only credit cards and possibly a car loan (and maybe a student loan as well). As long as you pay your bills on time, this won’t affect your credit score much at all.

Recently added credit—10% of your score

Finally, the credit bureaus take notice if you’ve recently taken on more debt—like signing up for another credit card. But if you have a good history and not much outstanding credit, then perhaps taking on a new card (or a mortgage) will actually add to your credit score.

It all comes down to how well you behave financially.

The credit report

All of the factors above go into building your personal credit history, which the credit bureaus use to create a credit report on you—and using all the details in this credit report they apply their secret formulas and determine a final credit score. Your credit report is important because it is reviewed when you are:
• Getting a loan
• Getting an apartment
• Getting a job (sometimes)

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Getting loans

When you apply for a loan, the lender asks the three credit bureaus to prepare one of these credit reports on you, which will include your credit score.

Generally the loan company will pull all three reports (one from each of the bureaus) and will either use an average of the three credit scores (they’re always different) or simply pick the middle number.

Getting an apartment

When you try to rent an apartment, the property owner or manager will always pull your credit report—they need to know whether you’ve ever skipped out on your rent (which will always wind up on your credit report).

They’ll also want to see how you handle your financial obligations in general. Even if you’ve never missed a rent payment, if you’ve missed other payments, few property managers will want to give you the keys to their apartments.

POP QUIZ

What does your FICO score measure?

QUIZ ANSWER
Your FICO score measures your credit worthiness.

Getting a job

Employers sometimes pull the credit reports of job candidates. Having a good credit score isn’t necessarily an indicator of what kind of worker you’ll be. But a credit report and credit score give strong clues about whether you take your responsibilities seriously.

So here’s another reason to behave responsibly with money—it could help you get the job you want.

Build and maintain great credit

Develop these good habits to build and maintain a great credit score

  • Never pay a bill late—any bill.
  • Don’t take on too much credit—a major credit card or two should be fine. Keep your debt-to-credit ratio low.
  • Pay off your credit cards every month.
  • Keep your credit cards as long as possible; don’t cancel them

FAST FACT

Your credit report lists inquiries made about your creditworthiness, showing how many inquiries were made for your credit and if you were given credit based on the inquiry.

Check your credit scores regularly

Now that you know how big a role your credit score will play in your life, you can understand how important it is to make sure the information that goes into that score is correct. Just as a loan company can pull your credit report, as we explained above, you can pull your own credit report—and you should, regularly, to make sure all the information in it is accurate.

It’s a good idea to do this least once a year, just to keep an eye on things. You can get your credit report and your credit score by going online to myfico.com or to any of the credit bureaus’ sites.

SMART MOVE

Pay your credit card balance in full every month (and pay it early).

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