Credit Scores 101
What is a credit score and why is it important?
Whether you are applying for a credit card, a mortgage or a car loan, creditors want to know how much risk there may be in lending to you. One way creditors evaluate risk is by using what is called a FICO credit score.
The three top consumer-reporting agencies (a/k/a credit bureaus), Experian, TransUnion and Equifax, regularly gather and compile data from hundreds of creditors. This data is compiled to form your credit report. The credit report shows when an account is opened or closed, loan amounts or credit limits, current balances, payment amounts and your payment history. Your payment history lists the dates when you made each payment on every account – and if they were paid on time. All of this information is run through a mathematical formula that results in a “FICO” score (which stands for Fair Isaac Corporation--they created this credit score model). Simply put, the higher your score, the better your credit!
It’s easy to check your credit report and score on your own. We advise you to do it at least once annually to make sure the report is accurate. You are entitled to one free copy of your credit report from each of the three bureaus once every twelve months. You can get more information about how to obtain your free copy on the Federal Trade Commission's website.
Why is your credit history important?
When you apply for credit from a lender, that lender will review your credit history and score to decide two things:
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Do you have the ability to pay back your loan?
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Are you willing to pay back the debt?
If your credit report indicates that you are either unable or unwilling to pay back your debts on time you may:
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Turned down for the loan.
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Limited amount you can borrow.
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Pay a higher interest rate.
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Mandatory insurance, co-sign or collateral to secure the loan.
Whether your thinking about buying a new home or refinancing your current home, it is a good idea to understand what your credit report says about you as a borrower before you apply. If you’ve got some past credit problems, don’t despair. There are things you can do to improve your score. Make a plan and put it in action. It’s worth the effort!
Five tips to help you improve your credit score.
1. When you find yourself in a hole, stop digging!
Resist the urge to open up new credit lines or to take out additional debt. If you are serious about improving your credit profile, make a plan and stick to it.
2. Get your credit report and score and study it.
Your problems may not be as serious as you fear, but even if they are, you can take steps to improve things. Understanding your credit report will help you identify the areas to work on.
3. Pay your bills on time.
This seems obvious, but sometimes when cash is short, the best intentions can become the worst of problems. If you absolutely cannot pay a bill on time, even a partial payment is better than nothing. Also, it may be in your best interest to contact the creditor and work out a new arrangement. This protects you while giving you more time to pay.
4. Avoid letting things go to collection agencies.
Nobody, even the creditor, wants to turn over a bad debt to a collection agency. The collection agency gets a big cut of any money they succeed in getting from you, which is obviously not the first choice of your creditor. Contact the creditor and let them know your situation before a collection agency becomes involved.
5. Don’t bounce checks!
Choose a bank that offers overdraft protection and keep track of what’s in your account. You’ll probably be charged a fee for overdraft protection when you use it, but this fee will be less than the bounced check fee and the credit problems that can go along with bouncing checks.
What you should do if your credit report is inaccurate...
Another good reason for studying your credit report is that incorrect information can be reported. You can take written action to report the error you see on your report and describe the accurate scenario. While these processes take a little time and perseverance on your part, consider it a project you’re doing for yourself and your future. Visit the Federal Trade Commission website to get more information on how to correct an error on your credit report.