In
this section you will learn things like, what
is a credit score, do I have more than one credit
score, how come my credit score was different
when I checked it and when the lender checked
it, what it costs me to have a low credit score,
how my credit score is calculated, how to improve
my credit score, how to obtain my real credit
score, important credit score facts, and even
how to add positive accounts to my credit report
and increase my credit score without actually
having to qualify for new credit.
Introduction
to credit scores
The
company that created the scoring model used today
by most lenders is called Fair
Isaac Corporation and commonly known as FICO,
for short. Fair Isaac Corporation is a California
Company founded in 1956 by Bill Fair and Earl
Isaac. They pioneered the field of credit scoring
for financial companies. They have expanded their
enterprise to cover decision systems, analytics
and consulting.
When
the three major credit bureaus calculate your
credit score using software from FICO, they come
up with what is commonly termed, your “FICO Score”.
Each credit bureau propriotizes their calculation
of this score by giving it their own name. Equifax
calls their version of the FICO score the “Beacon
score”; Trans Union calls their version of the
FICO score the “Empirica score” and Experian creatively
calls theirs the “Experian, Fair Isaac score”.
The “FICO score” is the score that over 70% of
lenders will use to decide if you qualify for
credit or not.
But
beware, many companies, even the credit bureau
themselves, have realized that there is lots of
money to be made selling credit scores so they
have created their own generic scoring models
designed to get you to buy their version of a
credit score model similar to that of FICO’s.
They will try to sell you a number called a credit
score, but not the credit score that your lenders
will use. If it is not your FICO credit score
it is probably not the credit score you want.
What
your credit score means.
The
credit score rating system is meant to develop
a snapshot of the risk you currently represent
to a lender. Several parameters in your credit
report, including payment history, length of account
history, number of open accounts, loans, mortgages,
public records, and others are formulated to produce
a 3-digit score between 300 and 850. There are
other scores used by lenders and insurance companies
(some of which are developed by FICO) such as
Application and Behavior scores. These other
scores take other information into account. Usually
a lender will use a combination of your credit
score along with other factors, such as income,
debt ratio, or current assets when determining
your risk. They all have the same objective, to
determine the borrower’s potential risk. Regardless
of whether the score was generated by FICO or
a system based on FICO parameters, they all yield
an industry standard 3 digit score. This score
usually places you in one of 3 main categories.
Low
Risk, Average Risk, and High Risk
Low Risk
If your credit score is above 680, you are generally
considered a lower risk and should have no problem
getting a good interest rate on your home loan,
car loan, or credit card.
Average Risk
If your credit score is below 680, you are average
or "sub prime" risk, and will likely
be offered less than favorable interest rates
and terms on your loans and credit cards.
High Risk
Below 580 is a high-risk credit score. Although
more difficult, you may still be able get a credit
card but will likely be required to give a security
deposit and be hit with high interest and fees.
You can forget about most home loans and the majority
of new car loans at this score. Below 580 is no
place to be. You will pay much, much more for
your credit transactions. You may even pay more
for your insurance rates. A very low score can
even prevent you from getting a job with many
companies.
What
it cost you to have a low score?
If you are financing or looking to finance a car,
having poor credit can mean higher down payments
and over 200% higher interest rate. The higher interest
shows up every month in a higher payment.
This
example is based on financing $25,000 for 60 months.
|
Credit Status
|
Rate
|
Payment
|
Over 5 years
|
Monthly Cost of
Bad Credit
|
|
Good
|
5%
|
$471.78
|
$0.00
|
$0.00
|
|
Mildly
damaged
|
8%
|
$506.91
|
$2,107.74
|
$35.13
|
|
Damaged
|
12%
|
$556.11
|
$5,059.82
|
$84.33
|
Bad
credit in auto financing can really hurt, but
it is nothing compared to the cost of bad credit
when a home is involved. A typical home can cost
between $90,000 and $245,000 more in interest
if you are buying the home with a low FICO score,
as indicated below.
This
example is based on financing $200,000 for 30
years, P.I. only.
|
Credit Status
|
Rate
|
Payment
|
Over 30 years
|
Monthly Cost of
Bad Credit
|
|
Good
|
5%
|
$1,073.64
|
$0.00
|
$0.00
|
|
Mildly damaged
|
7%
|
$1,330.6
|
$92,506.23
|
$256.96
|
|
Damaged
|
9%
|
$1,755.14
|
$245,339.76
|
$681.50
|
In
fact, in general, those with bad credit throughout
their life will pay approximately $250,000 more
in interest as opposed to those with good credit.
This is why it is so important to obtain and keep
a high score.
How
Credit Scores are Calculated
The
methods of calculating your FICO credit score
may differ slightly depending on the credit bureau.
When obtaining your credit score from one of the
Credit Bureaus it is important to understand that
your score is not coming directly from FICO, rather
it is adapted to each credit bureau’s report and
is given its own name:
Equifax
= Beacon Score
Trans
Union = Empirica
Score
Experian
= Experian/Fair Issac Score
Your
credit score is derived from your bureau data
and is calculated each time it is requested and
is not a permanent part of your credit file. Accordingly,
it will change every time data on your credit
reports change and may be slightly different each
time it is requested. Since each credit bureau
usually reports different information, your credit
score from each credit bureau will also be different.
However
your credit score is calculated, it will always
take into consideration many factors or categories
of information. No one piece of information determines
your credit score and all of these factors are
interrelated with one another. As the information
in your credit report changes, the importance
of one or several factors may change in your FICO
score. Lenders may look at many things when making
a credit decision, including your income and the
kind of credit you are applying for. However,
your FICO score does not reflect these facts,
as it only evaluates the information retained
by the credit-reporting agency.
Its
difficult to say exactly how the credit score
is calculated as FICO does not reveal the details
of their model. We do know that it is largely based
on the following factors.
|
1.
Payment History (Previous credit performance)
= 35%
2.
Outstanding Debt (Current level of indebtedness)
= 30%
3.
Amount of time credit has been in use (Credit
history length) = 15%
4.
Recent Inquiries (Pursuit of new credit)
= 10%
5.
Types of credit experience and credit in
use = 10%
|
1.
Previous Credit Performance (Payment History)
35%
A
lender wants to know what your payment history
is like. Have you paid everything on time, are
you late on anything now, etc… Your payment history
is usually the most important factor used in calculating
your score. In fact, even just one 30-day late
payment can have a tremendous negative impact
on your score. This “negative history” is exactly
what Credit Repair Consultants are dedicated
to improving for you. Each time a negative item
is removed from your credit it should have a positive
effect on your credit score.
Here
is more information on what the score looks for:
- Payment
history on your accounts. These include credit
cards, retail accounts (department store credit
cards), installment loans, finance company accounts
and mortgage loans.
- Collection
items and Public records—this includes judgments,
bankruptcies, suits, liens, collection items
and wage attachments. Most of these are considered
quite serious, although older items will count
less than more recent ones.
- It’s
all in the details. This includes specific details
on late and missed payments. Negative information/late
pays are determined using three factors.
- Recentness
- How long ago did the delinquency occur?
How
old is the late pay? A 30-day late payment made
just a month ago will affect your score much more
than a 90-day late payment from five years ago.
- Severity
- What level of delinquency was reached?
How
late was the payment made? 30 days, 60 days, 90
days or worst of all, is the payment still outstanding.
- Prevalence
- How many credit obligations have been delinquent?
The
amount of negative items as compared to your total
amount of available credit is another small factor.
For instance, 5 accounts showing 3 late payments
is much worse than 10 accounts showing 4 late
payments. One of the biggest sub factors is how
many accounts show no late payments. A good track
record on most of your credit accounts will increase
your over all FICO score substantially.
Note:
Note that paying an account that was previously
delinquent or in collection does not make that
account disappear from your credit report.
2.
Current Level of Indebtedness (Amount Owed) 30%
Are
your cards max-ed out? High balances, or more
precisely, balances that are close to your credit
limit can negatively affect your score.
The
creditor wants to know, Can the borrower pay me
and still afford to pay his other bills? These
are the types of questions that most borrowers
want to know and the answers are almost as important
as your previous credit history.
- Total
amount owed on all open accounts. Paying off
your credit cards in full every month does not
mean that they won’t show a balance on your
report. Your total balance on your last statement
is generally the amount that will show in your
credit report.
- Specific
types of accounts, such as credit cards and
installment loans are scored differently and
in conjunction with the overall amount owed
on all open accounts. This also factors into
your balance on each specific type of account.
For instance; you have a credit card with a
very small balance and no late pays. Even though
the balance is low, this still looks very good
as it shows that you are able to manage your
credit responsibly
- How
many accounts do you have open and how many
have balances? A large number of open accounts,
even with small balances, can indicate higher
risk of over-extension. This is weighted in
your FICO score but most lenders leave it to
their discretion as they have access to your
income amount. For the most part though it is
good not to have too many credit card accounts.
Closing credit accounts will not raise your
credit score and may actually hurt your credit
score.
- How
much of the total credit available to you, are
you using? In other words, are you close to
maxing out? For example, if you have a credit
card with an available credit line of $1000
dollars and you have a current balance of $850.00
or more, then you are nearly “Maxed out”. Several
credit cards or other debts with balances approaching
the credit limit will affect your score negatively.
Even if you have made your payments responsibly.
Your FICO score will factor your overall ratio
of debt to your overall limits.
As
a general rule keep your balances below 50% of
your limit or, if possible, pay the cards off
altogether. If you have to choose between paying
$1000 on three cards or paying off one card with
a $3000 balance, pay off the one card. Another
helpful tip- don’t forget to request a credit
limit increase every six months, or whenever your
credit card company allows you to qualify for
one. This will give you more “available” credit
and the ratio between your credit limit and what
you owe will be lower. Please note, you must have
the discipline to not use your new available credit
or you may not only due more damage to this ratio,
but you may become overextended.
- By
the way, if you already feel that you may
be overextended on your bills, contact a credit
professional. We suggest calling a certified
and knowledgeable credit counselor toll free
at 1-866-FIX-A-DEBT or visit http://www.debtconsolidationofamerica.com
for free information from a reputable, honest
and non-profit credit counseling service that
can have your payments and interest lowered.
It does no good to repair your credit if you
will not be able to keep it in good standing.
3.
Amount of Time Credit Has Been In Use (Length
of Credit) 15%
The
longer your accounts have been open, the better
your credit score. This factor only makes up about
15% of your total credit score, however, so even
young people and recent immigrants can still score
high overall as long as their other factors are
good. If you are new to credit your best bet is
probably just to open an account and be patient.
There is one technique that you may be able to
use, however. We will discuss it in detail later.
Just understand that the credit score takes into
account these factors:
