Personal Finance Essentials
Understanding Your Credit Score
One Number That Can Cost You Thousands
Or Save You Thousands
Your credit score tells lenders how much risk they’re taking when lending money to you. Many companies produce credit scores using proprietary formulas that compare you to other consumers; factors include your payment and length of credit history, amounts owed, available credit and variety of credit obtained. The higher your score, the better.
Two of the best-known are produced by Fair, Issac and Company (FICO’s top ranking is 850 points) and VantageScore (990). Your score will fall if you pay bills late, miss payments, use 80% or more of your available credit, open too many new lines of credit, file for bankruptcy, lose property to foreclosure, have liens filed against you or become unemployed.
How FICO Calculates Your Score
FICO’s point system has been developed over decades and assigns different values to the types of accounts you hold and your payment history. For example, you earn more points for having and actively using two to four credit cards than for having none at all – but carrying five or more cards works against you. Even simply applying for a new credit card costs you points, because FICO has found that people anticipating financial trouble often try to build up available credit before a crisis hits.
Missing a mortgage payment is viewed more harshly than missing a credit card payment. The system rewards consistency: the longer you have gone without a public record against you – such as an unpaid bill sent to collections or court – the better your score. Factors such as age, race, religion, national origin, marital status and sex are not part of the calculation.
What Improves Your Score
To improve your credit record, get current on all bills and stay current, reduce the amount you owe and keep balances under 25% of your available credit. Steady employment also improves your score. If you plan to buy a home in the next twelve months, think carefully before opening any new accounts – even ones that come with discounts or appealing introductory offers. Each new account temporarily lowers your score.
While your credit report is a historical record of your credit activity, your credit score is a statistical evaluation of how likely you are to make payments on time. Equifax, Experian and TransUnion each maintain files that include your credit score, but because scores are calculated by several vendors, each of the three firms is likely to show a different number. Unlike credit reports, you cannot obtain your credit score without paying for it.