All About Credit Scores

Important Information You Need to Know by Steve White, President and CEO of American Credit "Big brother is watching you." Even if you haven't read George Orwell's classic novel 1984, you've probably heard that famous line from the book. If Orwell was alive today and working on a sequel, perhaps he would write: "Big brother is watching your credit score." The Importance of Credit Scores Credit scores have assumed immense importance in our financial lives and many – perhaps the majority of consumers – don't even realize it. Never before have our financial transactions been so closely monitored by the credit bureaus and used to determine our credit risk based on the credit score that is calculated. A credit score affects how much interest we pay on mortgages, consumer loans, credit cards and more – to the extent that the difference between a good score and a bad one can be tens or even hundreds of thousands of dollars over our adult lives. That's pretty staggering. But it doesn't stop there. A credit score can affect your ability to get a job, a cell phone, rent an apartment, how much you pay for insurance or even opening a bank account. It's been described as your financial DNA. All of which is a strong argument for becoming an educated consumer on this subject. But for too many folks ignorance is bliss until reality hits home with the discovery that a huge barrier – in the form of a bad credit score – lies in front of buying a home or a car, or finding a job. For most consumers, the credit scoring system is as much a mystery as a Sherlock Holmes novel. There's so much confusing information out there – the bad mixed in with the good – that it's hard sorting the wheat from the chaff. So let's help you. Types of Credit Scores FACT: All credit scores are not created equal. FACT: The credit score you should pay attention to is the FICO® score. There are all kinds of promotions on the internet offering free credit scores, credit monitoring and other such services. The key to remember is that the score used by major lenders and about 90 of the top 100 financial institutions in the U.S. is the FICO® score. It's the global standard for measuring credit risk, based on a formula developed by Fair Isaac Corporation. FICO® scores range from 300 to 850, the higher the better. Other companies are selling credit scores based on their own models with different scoring ranges. The best place to get your FICO® score is straight from the company at myFICO.com or if you have applied for a loan ask your lender to give it to you. Under federal legislation, every credit bureau is required to give consumers one free credit report per year (visit annualcreditreport.com), but not a free credit score. Keep in the mind the major credit bureaus sell credit scores based on models that are different than FICO®. The closest to FICO® of the three is Equifax. TransUnion and Experian sell the Vantage Score, with a range of 501-980. The Importance of Checking Your Credit Score Lenders will obtain your FICO® score based on your credit reports from each of the big three bureaus and use these scores to determine your credit risk. Your credit reports may vary somewhat with each bureau as they may not have identical data and sometimes there are errors on your credit reports that can affect your credit score. Unless you find these errors and take action to remove them from your credit reports, they will stay there. That's why checking your credit reports at least once a year is a wise move because you never know when you might have to borrow money and it's best to be prepared. This is vital if you aim to buy a house in the near future. If you discover your credit score is low, it can take months to raise it. Buying a home is probably the most expensive purchase that you will make in your lifetime and securing the best interest rate will make a huge difference over the life of the mortgage. Here is a recent example that illustrates how credit score impacted the interest rate available on a 30-year fixed rate mortgage: Credit Score 740+ 720-739 700-719 680-699 660-679 640-659 620-639 <620 Interest Rate 3.750% 3.875% 3.990% 4.125% 4.250% 4.375% 4.500% (options are very limited for people with scores in this range) 4.750% (and likely not able to be done) Other Ways Your Credit Score Can Impact You Almost everyone uses credit cards today and you can pay through the nose with interest charges. To get the best terms, you need a high credit score. What if you just need to get an apartment? A bad credit score can get you turned down or force you to pay more money up front to the landlord. Looking for a job? Unless you are in one of only seven states that restrict the use of credit scores to screen job applicants, you could be out of luck. Competition for jobs in today's economy has never been tougher, so gain any advantage you can by having a high credit score. The states that restrict this practice – they consider it discriminatory – are California, Hawaii, Oregon, Connecticut, Illinois, Maryland and Washington. CoreLogic In addition to credit card records, consumer loan and mortgage payments, and collections, charge-offs and bankruptcies are also tracked by the major credit bureaus. Many of our financial dealings that used to go under the radar are now being captured by a fourth credit bureau: CoreLogic. CoreLogic is tracking evictions, child support payments, payday loan applications and property tax liens. It's being offered to mortgage and home equity lenders as an additional tool to screen applicants for credit risk. Maintaining a Good Credit Score How do you maintain a good credit score? The single greatest factor is payment history, which makes up 35 percent of a credit score. So pay those bills on time. Debt load is the next most important factor, making up 30 percent of a credit score. Try to keep credit balances at zero but if that's not possible try to keep the balance owing at no more than 30 percent. The other factors include length of credit history, which makes up15 percent of your credit score, types of credit (10 percent), and inquiries for new credit (also 10 percent). A few pitfalls to avoid include: Don't close an inactive credit card account as it could raise your overall debt-to-credit ratio and lower your credit score. Don't co-sign a loan unless you are prepared to risk lowering your credit score should the other person default. Don't max out or exceed credit card limits. The Bottom Line Understanding your credit score can seem daunting, but it doesn't have to be. If you have any questions about your personal situation, contact the professional who supplied you with this month's issue of YOU Magazine. Steve White is president and CEO of American Credit, a company that helps consumers optimize credit scores to qualify for mortgages, loans and credit cards at the best interest rates. American Credit uses a proprietary system based on federal law to ensure that clients' rights are protected and enforced. A veteran of the first Gulf War, Steve founded the Santa Monica, California based company 9 years ago.