Your credit score is much like an adult version of your GPA. Its a grade that measures your level of financial responsibility in relation to others. Banks and lending institutions use your credit score when you apply for a mortgage, an auto loan or a loan for home improvements or a business. Credit card companies use scores to determine who qualifies for a card and at what interest rate.
Increasingly, however, insurance companies, landlords and sometimes employers, study credit scores as a way to determine how responsible you are. Here are basics about where your credit score comes from and how to raise your score if its lagging behind the competition.
Credit Reporting 101
The most widely used credit scores are FICO® scores, created by the Fair Isaac Corporation. Top lenders use FICO scores to help them make credit-related decisions every year. FICO calculates scores based on information in consumer credit reports maintained at the credit reporting agencies.
Credit scores fall within a range from 300 to 850. Generally, a score of 700 or more is considered good, with 750+ rated as excellent. Most scores fall between 600 and 750. Here are generally accepted score range classifications: Excellent 750+; Good 700-749; Fair 650-699; Poor 600-649; Bad 600 or lower.
The three major credit reporting agencies are Equifax®, Experian® and TransUnion® and each may give you a different score. You can access your report once each year for free at AnnualCreditReport.com or call (877) 322-8228. This agency is the only official site directed by federal law to provide scores.
A top credit score generally means you can qualify for the most competitive loan rates and the most attractive credit card offers. Its in your best interest to keep your score high. If your score is below 650, you may not qualify for a loan or a credit card. And if you do, youll pay high interest rates.
Crunching the Numbers
A complex mathematical model is used to evaluate your financial reliability or your credit risk. Your score basically comes down to an estimate of how likely you are to repay a loan and to make payments on time. The two most important factors that determine your score are how you pay your debts and how much debt you owe.
Your credit score changes over time to reflect your current financial behavior and length of credit history. Accurate negative information can be reported for seven years; lawsuit or judgments for seven years or until the statute of limitations expires; and bankruptcy for 10 years. Factors not included in your score include race, religion, national origin, sex, age and salary.
The following factors and weighting determine your credit score:
Payment history – 35%. This includes your payment information, any financial judgments against you or bankruptcies, any overdue payments, amounts past due and the time elapsed since any adverse credit incidents.
Amount owed – 30%. Includes the amounts owed on individual accounts and the collective amount owed, number of accounts with balances, proportion of your credit line used and proportion of installment loans still owed.
Length of credit history – 15%. The amount of time since your credit accounts were established and active. A longer credit history is generally better than a short history.
New credit – 10%. A record of recently opened accounts, number of recent credit inquiries and establishment of positive credit history following any past payment problems.
Types of credit used – 10%. The number of various types of accounts including credit cards, retail accounts, installment loans and mortgages.
Raising Your Profile
If you find your score is less than excellent, dont despair. Its entirely possible to raise it in three steps:
1. Fix Errors on Your Credit Report
The Federal Trade Commission says about 5 percent of consumers have errors on credit reports significant enough to result in a higher price from a lender. About 20 percent have errors that have at least a small negative effect on scores. So when you check your credit score, dont automatically accept the information in the report as complete and accurate.
Check for possible errors, such as reports for late payments or other negative information, and if you have contrary evidence, dispute them to get them removed. Bureaus have 30 business days to respond and if the report is in error, you should see a bump in your credit score.
2. Stay Well Under Your Credit Limit
Your credit utilization – the amount of your credit limit you actually use – has a huge effect on your score. Financial advisors recommend you use no more than 30 percent of your total credit limit. Your overall limit as well as your per card limit both count.
Ways to manage your limit:
- Make small payments, often called micropayments, during the month to keep card balances down. Keep track of your credit purchases online and pay as soon as you see a purchase posted.
- Pay off any small balances on cards and stop using those cards.
- Request a higher credit limit. When your limit goes up but your balance remains level, your utilization is automatically reduced.
- Focus on paying down your cards with the highest utilization first.
- Consider moving some debt. If youre in credit card trouble, a debt consolidation loan from a reputable lender may offer a lower rate than your credit card companies. Pay off your cards with the loan money, stop using your cards and then concentrate on paying down the loan, making every payment on time.
3. Deal With Past Due Bills
In order to raise your credit score, you must pay on time, as payment history is a huge factor in your score. Each month an account is marked as delinquent hurts your score. If you are behind in any payments, call the creditor and ask if they will rescind the previous late payments so they wont continue to affect your score.
Going forward, focus on paying every bill on time in order to offset any negative credit history. This tactic may not work to quickly raise your score, but its essential for overall improvement.
Improving your credit score takes time and effort, but will be worth it when you get easily approved for loans and credit cards at attractive interest rates. Plus, youll have the satisfaction of knowing that youre financially responsible. Even if you have average or bad credit, dont give up. Do everything within your power to behave in a financially responsible manner and your score is bound to improve.