Series: Spending Money

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Keeping Score of Your Credit Score Terms of Use:

Ever wonder how stores can offer credit cards while you wait or how car dealers have on-the-spot financing? It’s all possible through the use of a credit scoring system.

You actually have a number score ranging from 300 to 850 based on information in your credit report, as it compares to millions of other people. Your credit score is a prediction of how likely you are to pay your bills. The higher the score, the lower the predicted risk (of your not repaying a loan).

Credit scores are used by lenders when you apply for a mortgage, car loan, and/or credit card. Believe it or not, the interest rate you receive is directly tied to your credit score. So people with high credit scores get the lowest rates!

A low score can cost you a lot of money. Let’s imagine you want to borrow $100,000 to buy a house and you’re applying for a 30-year fixed mortgage. If your credit score is high (720), you get a loan at 5.529% (for example) and make monthly payments of $570. The total interest you’ll pay is $105,060.

But what if your credit score isn’t high? For the sake of example, let’s say your score is 520 instead. The 30-year fixed mortgage will now have an interest rate of 9.289% and you’ll make monthly payments of $826.

This is $256 more per month that you’ll be paying (than in the first example) because of your credit score!

The total interest paid over the life of your mortgage will be $197,181 – a whopping $92,121 more than interest paid in the first scenario. If your score is lower than 500, you’ll have trouble even qualifying for a loan.

So who makes credit scores anyway? Equifax, TransUnion and Experian are the three major credit agencies that supply credit reports. When a credit card company or lender wants information on you, that company will buy a report from one or more of these agencies. Check out our article on Your Credit Report Card.

Chances are you have a different score with each agency. Some lenders even make up their own score based on your credit report. Your score can change over time: information stays on your record no more than ten years.

The score is based on a mathematical formula developed by Fair Isaac Corporation (clickhere). That’s why your credit score is often referred to as a FICO score.

Most lenders say that a score above 620 is creditworthy, and 670 or higher is excellent. Among people who have a FICOâ score, about 60% have scores of 700 and above.

Series: Spending Money

Page 2 of 3

Keeping Score of Your Credit Score Terms of Use:

Here’s the breakdown of what goes into your FICOâ score:

Payment History

35%

Amount Owed and Available Credit

30%

Length of Credit History

15%

Type of Credit in Use (mix of credit cards & loans)

10%

New Credit Applications

10%

As you can see, payment history (and especially paying bills on time) is the most important part of your score. Pay late and you’ll end up paying higher interest rates for home and auto loans.

The longer your history of on-time payments, the better your credit score. Some experts advise getting into the habit of paying bills when you receive them, rather than risking a late payment fee, finance charge and a big “D” (for delinquent) on your account which could affect your credit score. You lose points if you have payments more than 30 days’ late and if you are late on more than one account.

Points also get subtracted for a “charge-off.” This is a loan that the lender could not get you to pay, so he or she wrote it off on an income tax return as a bad debt.

Points are added or subtracted based on how much you owe compared to how much you could owe. Someone who has a big line of credit but does not borrow much is a better

credit risk than someone maxed out on credit cards (charged to your maximum credit limit).

Your credit report does not have information on your salary and assets. Therefore, a high salary and lots of money in the bank doesn’t help if your balances hover near your credit card limits. Some experts say you should keep below 50% of card limits and rotate the cards.

Your FICOâ score reflects the average age of all your accounts. Accounts kept a long time help your score. This is why it is better to keep one credit card a long time rather than to hop around and open new ones in order to get lower interest rates.

The longer and smoother your credit history, the higher your score. This rule works against young people and people who pay in cash. If you never use credit, you can improve your FICOâ score by using automatic payment systems for your utility bills, cable, newspaper, and so forth. This will create a payment record at the agencies.

“Type of credit in use” is about your mix of credit cards, retail accounts, finance company loans and mortgage loans, and again about how long you’ve had each one. Too many accounts lower your score.

Many stores will give you a discount on your purchase if you open a credit card account with them, but having a lot of such accounts is bad for your FICOâ.

Series: Spending Money

Page 3 of 3

Keeping Score of Your Credit Score Terms of Use:

Some lenders rate each credit card account from 1 to 10. You are scored on when you opened the account, whether it’s a joint account, what your high balance was, if your payments were on time, if the account is still open, unpaid or closed, and how much you still owe.

You’ll get points taken away for bankruptcy, tax liens and other legal judgments, and having too many “inquiries.” Inquiries are requests from lenders and employers for your credit history.

Up until a few years ago, you weren’t allowed to see your FICOâ score. Consumer groups put pressure on Congress to change that, so now you can buy a copy of your report and FICOâ score from any number of sources, including Fair Isaac Corporation.

It’s advised to check your credit reports at least once a year to make sure there are no errors. Even so, the exact mathematical formula of how your FICOâ score is figured is a trade secret.

If you are denied credit, you are entitled to a free copy of your credit report.

As for credit repair promises advertised on TV and elsewhere, the Federal Trade Commission says that these companies can’t deliver on promises to erase your bad credit and may only be after more of your money.

The only sure fire way to clean up your credit record is to repay debts on time for several years.  For more information about your credit score or how to repair your credit file, please visit the Institute of Consumer Financial Education or the Federal Trade Commission web sites.  You can also call the FTC toll-free at 1-877-FTC-HELP (382-4357).  To get a free credit report, go to:  www.annualcreditreport.com.

See what you learned.

Check out "Your Credit Report Card"