This week we’re kicking off a new subject for the blog with an article about your credit score: what it is, how it’s determined, and how that number can impact your life.
What is a credit score?
When someone talks about your credit score, the person is really talking about your FICO score. Anyone who has had a credit card or a loan for at least six months has a credit score. If you are trying to get a credit card, a car loan, or a mortgage, lenders will use your FICO score to decide whether to give you additional credit and how much interest you will pay. Your score can also be a factor in just about any situation that involves your ability to pay, such as renting an apartment or starting an insurance policy. The Fair Isaac Corporation (FICO) developed the most widely used scoring system, which is based on a 300–850 point scale, in conjunction with the three principal credit reporting agencies: Equifax, Experian and TransUnion. Most people have a score in the 600s and 700s. A score in the 800s is considered excellent. If your score is less than around 620, you may find it difficult to obtain financing. If you do get it, you will probably pay a higher interest rate. According to Tom Quinn, consumer credit expert at Credit.com, your three scores are usually within 20 points of each other.
How your credit score is determined
Your FICO score is based on different factors. The way you have managed your credit in the past is seen as an indicator of your ability to pay in the future. Your credit score changes over time based on how you handle your personal finances.
- 35 percent of your credit score is determined by your payment history. Any foreclosure, bankruptcy or delinquent accounts assigned to a collection agency will negatively affect your score.
- 30 percent of your score is the amount of debt you currently carry, and the proportion of your debt to your available credit. Generally, it’s best not to exceed 50 percent of your credit limits. Paying down your debt will improve your score.
- 15 percent of your score is the length of your credit history. Several years of history demonstrates your experience in managing credit and will generate a higher score than a shorter credit history.
- 10 percent of your score is based on how often you request new credit. You should request only the credit you need. If you are getting quotes on a loan and get them all within the same two-week (14 day) period they are “lumped together” as just one inquiry on your credit report.
- The other 10 percent of your score is based on the types of credit you have such as credit cards, installment loans, accounts with financing companies and mortgages. This gives lenders an idea of your experience in managing different types of credit.
Getting a copy of your credit report
By law, you are entitled to one free copy of your credit report from each of the three bureaus once every 12 months. Don’t believe the commercials you might see on TV advertising free credit report services. The only site established by law for obtaining free copies of your credit report is annualcreditreport.com.
It’s important to check your credit report periodically. Some experts suggest requesting a copy of your credit report from one bureau every four months. For example, in January you could check your report from Experian, in May you could check your report from Equifax, and in October you could check your report from TransUnion. Following this practice will allow you to spot any errors relatively quickly. In another blog we’ll cover what to do if you find a mistake on your credit report.
You should also check your credit report a few months before a major purchase such as a car or home. Errors affect your credit score and should be corrected before you apply for credit.
Keep in mind that you’re entitled to free copies of your credit report. In most cases you have to pay to find out your credit score.
How to get a good credit score
We’ll cover this in more depth in another blog, but in general the path to a good credit score is simple: Pay your bills on time. Keep your balances under 30% of your total credit limit. Apply for new credit only when you really need it. (That means not opening a store credit card every time the cashier offers one to you.) Keep your credit cards open after you’ve paid off the balances – especially the oldest accounts – because the longer your credit history, the higher your score.
Personal Finance 101: Credit Score Basics by Kevin Hagen
Understanding Your Credit Score by Brooke Nevils