Your Credit Score

Credit Score is a statistical technique used by lenders to determine whether to extend credit to a borrower, and if yes, how much. The system is often considered more accurate than a qualitative assessment of a person's credit worthiness, since it is based on actual data.

The actual score is a number that rates the likelihood you will pay back a loan. Scores range from 350 (high risk) to 950 (low risk).

There are a few types of credit score; the most widely used are FICO scores, which were developed by Fair Isaac & Company, Inc. for each of the credit reporting agencies. FICO scores are your credit rating. Most lenders base Three Credit Bureau Logos approval on them. You have three FICO scores, one for each credit bureau.

When performing credit scoring, most lenders will undertake a statistical sample of individuals to see what factors have the most effect on credit worthiness.

Once these factors and their relative importance are established, a model is developed to calculate a credit score - a number indicating how credit-worthy the applicant is.

Some of the factors considered when developing a credit score model include outstanding debt, the number of credit accounts maintained, age, income, credit history, etc. Normally a credit scoring model should not consider such criteria as race, sex, marital status, national origin, or religion. Past delinquencies, derogatory payment behavior, current debt level, length of credit history, types of credit and number of inquiries are all considered in credit scores.

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 score.

How Influential Is Your Credit Score?

Your credit score, or FICO score, is arguably one of the most important pieces of information in your financial life as lenders, landlords, insurers, utility companies and even employers scrutinize this rating.

The Median FICO Score in the U.S. is 723. Only about 11% of the surveyed population ranks above 800; 29% ranks between 750 and 799. As you improve your FICO® scores, you pay less when you buy on credit - whether purchasing a home loan, cell phone, a car loan, or signing up for credit cards. For example, if your credit score is 580, you are likely to pay nearly three percentage points more in mortgage interest than someone with a score of 720.

To put it another way, the payments on a $150,000 30-year fixed-rate mortgage would be about $890 if you qualify for the best rate, according to Fair Isaac, the company that created the FICO score. That same loan could cost more than $1,200 a month if your credit is poor.

To that end, you'll want to check your credit scores periodically, correct any errors on your reports and take steps to improve your score over time. The secret to a better credit score is to pay your bills on time and keep your balances low.

To help consumers understand their scores, CFA and Fair Isaac have prepared a free brochure now available online. Also the Federal Citizen Information Center (FCIC) credit score brochure contains the most important information about the score most businesses use - the FICO credit score - including what factors influence its rise and fall, and how consumers can get their own scores.

Repairing Your Credit Score

If you’ve had a few problems getting the bills paid lately, you are probably wondering what you can do to repair the damage. Or maybe your credit is OK, but you'd like to make it better. After all, the better your credit, the lower the interest rates you can score on mortgages, car loans and credit cards.

Anyone who wants to improve a credit score should first do some basic housekeeping. First of all you should get a free copy of your credit report from one of the three major credit bureaus. Once you have it you should study it for any mistakes and ask the bureau to remove incorrect information.

Once that’s accomplished, you can start to work on improving your score using some or all of the following steps:

Pay your bills on time - The most important factor for a good credit score is paying your bills on time. Payment history is the single most important factor in determining your credit score, making up 35% of the total. Since recent history carries more weight than what happened five years ago, getting in the habit of making on-time payments is an incredibly powerful way to start rebuilding your credit rating.

Pay down your debts -- and consider charging less - Lenders like to see plenty of breathing room between the amount of debt reported on your credit cards and your total credit limits. The more debt you pay off, the wider that gap and the better your credit score.

Credit scores don’t distinguish between those who carry a balance on their cards and those who don’t. So charging less can also improve your score -- even if you pay off your credit cards each month.

Don’t close old, fully paid-off accounts - Closing accounts can never help your score, and often it can hurt. Shutting down credit accounts lowers the total credit available to you and makes any balances you have loom larger in credit score calculations. If you close your oldest accounts, it can actually shorten the length of your reported credit history and make you seem less credit-worthy.

Use credit counseling - If you’re overloaded with high-interest debt and are in danger of falling behind on your payments -- or you already have -- consider working with a non-profit agency such as Consumer Credit Counseling Services to set up a debt repayment plan. These services can negotiate lower interest rates and help you pay off your bills within a few years. Contrary to what you might have heard, credit counseling probably won’t hurt your credit score.

Avoid bankruptcy if you can - Bankruptcy is the nuclear bomb of the credit world -- worse than delinquencies, loans or collections. Its impact, however, depends on how many black marks you made on your credit before you filed. Bankruptcy can knock 200 points, or more, off the score of someone with otherwise good credit. People with multiple delinquencies or collections on their reports will see less of a decline because their scores are low to begin with. Either way, recovering from a bankruptcy can be tough. Once a score is pushed below 620, which bankruptcy inevitably does, credit becomes scarce and far more expensive.

Some Credit Score Myths

Make sure you're not falling for any of these common credit score myths.

Myth 1 - You only have one credit score. In truth, you have three credit scores, one from each of the three major credit bureaus. These scores can vary by as much as 50 points or more and it's a good idea to check all three.

Myth 2 - Checking your own credit will lower your score. You can check your own score as many times as you want without impacting your score but make sure you do so via the bureaus or a legitimate score seller like MyFICO.com rather than, say, at a car dealership.

Myth 3 - Your age, income and sex are factored into your score. None of this information has any bearing on your score. Your employment is something that is listed on the credit bureau report but doesn't affect the score itself.

Myth 4 - A higher salary will boost your score. Paying off your debts will improve your score. Earning more money, winning the lottery or inheriting a fortune, however, will not because, again, your net worth and income are not factored into your score.

Myth 5 - To remove un-favorable info just dispute it. If there is information in your report that is legitimately inaccurate, you should by all means dispute it. Credit agencies are obligated to investigate credit inaccuracies within 30 days or remove disputed information. But don't fall for so-called credit repair companies promising to remove unfavorable (though accurate) information from your credit reports to "instantly" improve your score.

Myth 6 - Shopping around for a loan hurts your score. When you apply for a loan or get pre-approved the creditor checks your credit report, which shows up as an inquiry to your credit. While it's true that too many inquiries to your credit will lower your score, you absolutely can shop around for a mortgage, home equity loan or car loan without worrying about damaging your credit. As long as the same kind of inquiries are made within 14 days of each other, they count as one inquiry on your credit score..

Myth 7 - Credit card offers are hurting your score. Credit card solicitations, while annoying, don't affect your credit score.

Consumer Credit Counseling - Get relief from your debt with consumer credit counseling services!