CREDIT SCORE BASICS
EVERYTHING YOU NEED TO KNOW
On the road to financial freedom you cannot bypass your credit situation. Sometimes just hearing the word “credit” can subject us to all kinds of emotions such as fear, guilt, embarrassment and shame. Experiencing those types of feelings at the mention of a word can make you avoid it altogether. Although these reactions can be very real and paralyzing, it is in your best interest to know and understand what your credit score is and how it is affecting you. We cannot change what we ignore.
Robert Ventour, MBA, the Founder and CEO of Timothy Roberts & Associates LLC explains it this way, “Change is Inevitable, Growth is Optional.” If it is your goal to grow financially you have to push pass your emotions and be willing to be financially educated, equipped and empowered. Understanding your credit score and how it works for you is a great place to start…so let’s go!
WHAT IS A CREDIT SCORE?
A credit score is a three digit number that is generated by using the information in your credit report. Credit scores are designed to help creditors predict your credit worthiness and how likely you are to be delinquent on your payments. Your credit score serves as the determining factor in if a creditor will extend credit to you and if credit is extended the creditor can decide how high your interest rate will be based on your score.
HOW IS A CREDIT SCORE DETERMINED?
Credit scores are determined based on the information in your credit report. Although a credit report and a credit score are closely associated, they are not the same. There are three major credit bureaus that collect your personal and financial information; Experian, Equifax and TransUnion. Credit reports include personal information that is specific to you such as your name, aliases of your name, present and past addresses, places of employment and your Social Security number. It also includes loans, accounts in collection, open and closed credit card accounts, bankruptcies and liens. All of this information is compiled and becomes your credit report. You are able to get one free credit report from each credit bureau once a year. You can obtain your reports through AnnualCreditReport.com.
The information contained in your credit report is used to calculate your credit score. There are five major elements that make up your FICO (Fair Isaac Corporation) credit score. The FICO score is the most widely used. Please note that there are different credit score models even within the FICO model for different purchases that may weigh scores differently. Here is an example of one model.
Payment History - 35%
Paying your bills on time is very important and is the biggest factor in calculating your credit score. A late and/or slow payment history will negatively affect your credit score no matter the amount of the payment or debt. You may think that a payment of $50 does not matter much in comparison to a higher payment of maybe $250. Well, as far as payment history is concerned the amount is irrelevant. It is your timeliness and consistency that is important as your credit score is calculated.
Amounts Owed - 30%
How much do you owe on your existing debt? How is your existing debt distributed? The answers to these questions are indicators to creditors of your capacity to take on additional credit obligations. It does not depend so much on whether the amount you owe is high or low. What is taken into consideration is the amounts you owe in relation to your payment history and the types of credit you have been extended. Credit card debt is usually the worst type of delinquent credit and should be kept at 30% of your total credit card usage. For example, only $300 of a credit card with a limit of $1,000 should be used monthly to keep utilization at 30%.
Length of Credit History - 15%
The longer your credit history, the better it is for you. The length of your credit history is an indicator to creditors that the other elements of your score are truly representative of the credit risk you would impose. Having a credit history of several years tells a better story than a history of a few months. Your credit history gives insight into the true state of your finances and your behavioral patterns concerning your debt.
Types of Credit Used - 10%
Having a variety of credit sources can boost your credit score, but only counts as 10% of your calculated FICO score. The diversity of your credit accounts shows that you are exposed to more than one type of credit and that you are able to manage them efficiently. Credit accounts are categorized as credit cards/revolving credit, installment loans, mortgages and consumer finances.
New Credit - 10%
This element of your credit score is based on any hard inquiries that are made into your credit. This includes applying for new credit and any accounts you have recently opened. The number of times that lenders request your data in a specific length of time will affect your credit score. Inquiries for items such as mortgages, car loans and student loans take 30 days before they affect your score. It is also expected that consumers will shop for the best interest rate; therefore searches of these type that happen within 14 to 45 days are counted as a single search. Credit score inquires for reasons other than obtaining a loan such as checking your own score, background checks and as a requirement for employment do not affect your credit score.
WHAT’S GOOD? WHAT’S NOT SO GOOD?
Your FICO score will be between 300 and 850, the higher score being the best. Different creditors use different scores, but as stated earlier the FICO score is the most commonly used. Here is the breakdown of what might be considered a good score vs. a not so good score.
Poor Credit - Anyone with a FICO score under 630
Average or Fair Credit - Between 630 and 690
Good Credit - Between 690 and 720
Excellent Credit - Anything above 720
HOW DOES YOUR CREDIT SCORE AFFECT YOU?
There are two general ways that your credit score can have an effect on you:
- It can determine if you are approved for financial products
- It will determine your interest rate once approved
A low credit score can disqualify you for a product or service that you are trying to obtain. Even if you are approved, a low credit score can significantly raise your interest rates. Credit scores are also used in other transactions such as renting a home or apartment, purchasing services such as cell phone service, utilities and insurance products. These companies may charge you a higher rate for their services as well as require a deposit before extending service. A low credit score can also hinder you from obtaining the job that you want.
HOW DO YOU CHECK YOUR CREDIT SCORE?
The annual credit report that you can obtain from the three major credit bureaus does not contain your credit score. You can get your credit report from several sources. Check your credit card or loan statements, talk to a non-profit credit counselor, buy your score directly from a credit reporting agency or online for free. You can get your credit score at CreditKarma.com not to be confused with your credit report.
HOW CAN YOU IMPROVE YOUR CREDIT SCORE?
Once you know your credit score you can take action to improve it if it is not where you want or need it to be in order to meet your financial goals. Improving your credit score is not an overnight process, but there are several things that you can do to put you on the right path.
- Know your credit score and request your credit report.
- Review your credit report for accuracy.
- Clean up your credit report. Dispute inaccuracies and pay off collection items and old debt.
- Pay your bills on time.
- Keep your credit card balances below the limit.
- Keep credit inquiries to a minimum.
- Make sure you have a diversified credit mix.
- Re-establish your credit by responsibly opening up new accounts and paying on time, i.e. secured credit card.
When we remove the mystery of something we are afraid of, that issue becomes easier to deal with. So it is with credit and your credit score. It is always our endeavor to add value to you at Timothy Roberts & Associates LLC. We hope that this information has been helpful to you. Pass it along to friends and family. Each one, reach one! Follow us on Facebook and LinkedIn to receive updates and helpful financial information. Also, check out our website at www.timothyrobertsllc.com for great information to assist you on your path to financial freedom. Until next time remember…
Your Interest is our Only Interest!