Guest post by Miranda Harwell, Executive Director of the Community Financial Education Foundation
Lately, it seems like numbers are taking over my life. There is the dreaded number 30 that haunts me like that tuna fillet I cooked last week in an attempt to be healthy. Then there’s that annoying four digit pin number you need for just about everything (I coined my token pin for the day and month my last name will officially go back to Gregory. A glorious day, no doubt!) In this new age of technology you need a number and password for everything. We have to remember our social security number, our spouse’s social security number, phone number, cell number, bank account number (who can ever remember that?), oh and of course the date of the last day of…well, you get point. We have a lot of numbers.
This Finance Friday is dedicated to a very important number and I would be willing to bet dollars for donuts most of us do not know it. This illustrious number I speak of is known as your “credit score.” Wait! Don’t stop reading now. I promise the knowledge presented below could really save you some major coin and perhaps make your financial future smooth sailing (or at the very least, a little less nauseating.)
So here is the deal. A credit score is a complex mathematical model that evaluates many types of information in a credit file. Credit file meaning, any line of credit you have EVER been granted, your history of paying on time – cell phone, utilities etc. This score is used by a lender to help determine whether you qualify for a particular credit card, loan, or service. Most credit scores estimate the risk a company incurs by lending you money or providing a service – specifically, the likelihood that you will make payments on time in the next two to three years. Generally, the higher the score, the less risk the person represents.
In layman’s terms, this number represents your street cred. Key point: If a lender loans you money, will you pay it back?
Americans are entitled to one free credit report within a 12-month period from each of the three credit bureaus. The three major credit bureaus are: Equifax’s ScorePower, Experian’s PLUS score, and TransUnion. These three credit bureaus run www.AnnualCreditReport.com, where users can get their free credit report. If you want to know your actual credit score….well, that will cost you. Credit scores are available as an add-on feature of the report for a fee.
There are several different companies on the market these days offering to provide consumers with credit reports. Case in point, www.FreeCreditReport.com. You know the marketing ploy. The annoying guy on the guitar singing about how his credit was “whack, now he is riding in a new sub-compact.” My favorite commercial was the one where he got married and did not know his “girl’s” credit was “whack” and now they are living in her parent’s basement. I totally could have done without that one, because he already admitted in the commercial earlier that he had bad credit. Why was it her fault? Just saying.
OK, I digress: about 60 percent of people have credit scores of 700 and above. The best number to have is 720 or above. If your score is 720, there’s really no need to try and raise it because lenders lump you in the same category as folks with a score of say 800 or 820. At 720, you are viewed as a safe risk and typically receive a loan without problem and at a low interest rate. However, if your number is below 700, it’s definitely worth your while to try and pump it up.
Here is how the credit nerds determine your score:
* 35 percent Payment History: Having a history of making payments on time and no missed payments on your bills is one of the most important items lenders look for.
* 30 percent Amount Owed: This measures the amount you owe relative to the total amount of credit available. Someone closer to maxing out all their credit limits is deemed to be a higher risk of late payments in the future and this can lower their credit score.
* 15 percent Length of Credit History: In general, a credit report containing a list of accounts opened for a long time will help your credit score. The score considers your oldest account and the average age of all accounts.
* 10 percent New Credit: Opening several new credit accounts in a short period of time can lower your credit score. Say no to the lady at the counter offering you 10% off your purchase if you open a card. Also multiple credit report inquiries can represent a greater risk, but this does NOT include any requests made by you, an employer or by a lender who does so when sending you an unsolicited, “pre-approved” credit offer. Also, to compensate for rate shopping, the score counts multiple inquiries in any 14-day period as just one inquiry.
• 10 percent Types of Credit in Use: Your mix of credit cards, retail accounts, finance company loans and mortgage loans is considered.
OK, so say you need to do a little credit score make over. The first step is admitting it, right? Here is what you can do.
You can’t raise your score overnight, but you can do so fairly quickly. The scoring formula gives more weight to recent activity. So, even six months of “good behavior” will have an impact, demonstrating that you have cleaned up your act. Because payment history comprises the largest part of your credit score, paying bills on time is obviously going to have the largest positive impact.
The fastest way to improve your score is to pay down balances. This lowers the amount of credit you’re using compared to how much credit you have available to you. Remember, scores reward people who use a smaller percentage of their available credit. Some people suggest never using more than 50 percent of your limit on any card. Avoid opening a lot of new accounts at once – this makes lenders queasy – particularly if you don’t have a long credit history. Many recommend not having more than five credit cards. If you decide to close some credit accounts, close the newer accounts first. However, don’t close more accounts than necessary because this lowers your ratio of debt to available credit.??Rotate and use all of your cards – a dormant credit account will not help your score. If you do have a late payment, it’s worth a call to the lender to see if they will remove this information from your records in a “goodwill adjustment.” You can choose to dispute the late payment report. While it’s in dispute, the item will stay on your credit report but not factor into your score. If you have a something negative on you report; be strategic. Word.
While there’s no question that having a good credit score is essential, it’s also important to point out that scores do not take your age, income, assets or employment history into account.
Accurate negative information generally can be reported for seven years, but there are exceptions:
• Bankruptcy information can be reported for 10 years;
• An application for more than $50,000 worth of credit or life insurance has no time limitation;
• A lawsuit or a judgment against you can be reported for seven years or until the statute of limitations runs out, whichever is longer; and
• Tax liens stay on 7 years from the date PAID.
The lesson learned today is this… Your credit score is an important number. You need to get your free credit report to see your history. If you are really serious, pay the extra $30 and find out your credit scores from all three agencies. If there is anything you can dispute, do it. This might take up your Friday afternoon but will be totally worth it. Your score means the difference from getting a mortgage at 5% or 11% interest. This is huge. Don’t let something minor that you can dispute affect the next seven years of your life. Mistakes happen, be proactive and get your financial ducks in a row.
And don’t forget to visit my website to sign up for my Borrow Smart America program. You can’t expect to become a reformed shopaholic until you start getting smart about the financial system and about your own financial situation. Complete the free online program and you’ll not only learn how to save, budget and repair your credit, but you’ll also qualify for a free gift – Quicken Software donated to us by Intuit to help your reformation transformation.
