• How important is my credit score?
Credit scores are vital to your financial health. A credit score, sometimes referred to as a FICO score (FICO is an acronym for the Fair Isaac Corporation) is a number that helps lenders predict how likely you are to make your credit payments on time. Each score is based upon the information in your credit report. Fair Isaac’s FICO scores are the most used credit bureau scores in the world. They are available through all of the major consumer reprting agencies in the United States and Canada: Equifax, Experian and TransUnion.
Credit scores matter because they affect whether you can get credit and most importantly, what you pay for credit. Not all credit is created equal. Two individuals may apply for a similar loan and the one with a higher credit score may be eligible for a lower interest rate, which in the case of a 30-year mortgage can save tens of thousands of dollars over the life of the mortgage.
For example, consider an individual that wants a 30-year mortgage loan and their FICO score is 720. They could qualify for a mortgage with a low 6.2 percent interest rate. However, if their score was 580 they may pay a 9.4 percent interest rate, which is a full 3 percent more in interest. On a $100,000 mortgage loan, that 3-point difference would cost them $2,600 a year, adding up to $79,500 more over the 30-year lifetime of the loan.
Whether you are buying a home, a car or applying for a credit card — lenders want to know the risk they’re taking by lending your money. FICO scores are the credit scores that most lenders use to determine your credit risk. Your FICO credit scores (you have one score from each of the three major credit bureaus) can affect how much money a lender will lend you and at what terms (interest rate).
So, taking steps to improve your FICO scores can often help you qualify for better rates from lenders — which can save you money. Improving your credit scores can help you lower your interest rates, speed up credit approvals, reduce the deposits required by utilities, get approved for leases and get better credit card, auto loan and mortgage offers.
FICO scores range from 300 to 850 — higher is better. Your FICO score is calculated using the information in your credit reports. These reports contain all of the information that each credit bureau has on file about you. Credit reports show a few examples of the types of information that the credit bureaus collect, such as your credit accounts, how many times lenders have requested information about your credit (Inquiries), and how many times lenders have turned your account over to a collection agency (Collections).
What’s in your FICO score?
FICO scores are calculated from a lot of different credit data in your credit report. This data can be grouped into five categories:
Payment History – 35 percent
Amounts Owed – 30 percent
Length of Credit History – 15 percent
New Credit – 10 percent
Types of Credit Used – 10 percent
These percentages are based on the importance of the five categories for the general population. For particular groups — for example, people who have not been using credit long — the importance of these categories may be somewhat different. A FICO score takes into consideration all these categories of information, not just one or two.
Your payment history is approximately 35 percent of a FICO score. Have you paid your credit accounts on time? Late payments, bankruptcies and other negative items can hurt your credit score. But a solid record of on-time payments helps your score.
How much you owe is approximately 30 percent of a FICO score. FICO scores look at the amounts you owe on all your accounts, the number of accounts with balances and how much of your available credit you are using. The more you owe compared to your credit limit, the lower your score will be.
The length of your credit history is approximately 15 percent of a FICO score. A longer credit history will increase your score. However, you can get a high score with a short credit history if the rest of your credit report shows responsible credit management.
New credit is approximately 10 percent of a FICO score. If you have recently applied for or opened new credit accounts, your credit score will weigh this fact against the rest of your credit history. When you apply for credit and a lender checks your credit history, your score may drop a little, usually less than five points. FICO scores do not distinguish between your search for many new credit lines and rate shopping for just one mortgage or an auto loan. If you need a loan, do your rate shopping within a focused period of time. Such as 30 days to avoid lowering your score.
Other factors are approximately 10 percent of a FICO score. Several minor factors also can influence your score. For example, having a mix of credit types on your credit reports — credit cards, installment loans such as mortgage or auto loan and personal lines of credit — is normal for people with longer credit histories and can add slightly to their score.
No one piece of information or factor alone will determine your score.
The importance of any factor depends on the overall information in your credit report.
For some people, a given factor may be more important than for someone else with a different credit history. In addition, as the information in your credit report changes, so does the importance of any factor in determining your FICO score. Thus, it’s impossible to say exactly how important any single factor is in determining your score — even the levels of importance shown here are for the general population, and will be different for different credit profiles. What’s important is the mix of information, which varies from person to person, and for any one person over time.
What’s not in your credit score?
By law, credit scores may not consider your race, color religion, national origin, gender and/or marital status, and whether you receive public assistance or exercise any consumer right under the Federal Equal Credit Opportunity Act or the Fair Credit Reporting Act.
Your FICO score only looks at information in your credit report.
However, lenders look at many things when making a credit decision including your income, how long you have worked at your present job and the kind of credit you are requesting. Your score considers both positive and negative information in your credit report. Late payments will lower your score, but establishing or re-establishing a good track record of making payments on time will raise your FICO credit score.
Payment history tips
Pay your bills on time. Delinquent payments and collections can have a major negative impact on your FICO score. If you have missed payments, get current and stay current.
The longer you pay your bills on time, the better your credit score. Be aware that paying off a collection account will not remove it from your credit report. It will stay on your report for seven years. If you are having trouble making ends meet, contact your creditors or see a legitimate credit counselor. This won’t improve your credit score immediately, but if you can begin to manage your credit and pay on time, your score will get better over time.
Amounts owed tips
Keep balances low on credit cards and other “revolving credit.” High outstanding debt can affect a credit score. Pay off debt rather than moving it around. The most effective way to improve your credit score in this area is by paying down your revolving credit. In fact, owing the same amount but having fewer open accounts may lower your score.
Don’t close unused credit cards as a short-term strategy to raise your score. Don’t open a number of new credit cards that you don’t need, just to increase your available credit.
This approach could backfire and actually lower your credit score.
Length of credit history tips
If you have been managing credit for a short time, don’t open a lot of new accounts too rapidly. New accounts will lower your average account age, which will have a larger effect on your score if you don’t have a lot of other credit information. Also, rapid account buildup can look risky if you are a new credit user.
Types of credit use tips
Apply for and open new credit accounts only as needed. Don’t open accounts just to have a better credit mix — it probably won’t raise your credit score. Have credit cards — but manage them responsibly. In general, having credit cards and installment loans (and paying timely payments) will raise your credit score. Someone with no credit cards, for example, tends to be higher risk than someone who has managed credit cards responsibly.
Note that closing an account doesn’t make it go away. A closed account will still show up on your credit report, and may be considered by the score.
Information about your credit score can be found at www.myfico.com or by calling 866-406-7204.
• The Kauai Board of Realtors is a nonprofit organization comprised of 700 Realtors and associates from the bank, mortgage and escrow industry. The board answers reader questions twice a month in the Business section. For more information, visit www.kauai-realtor.com