Understanding Your Credit

What Is A Credit Score?

A credit score is a number generated by a mathematical formula that is meant to predict creditworthiness. Credit scores range from 300-850. The higher your score, the more likely you are to get approved for a loan. The lower your score, the less likely you are to get approved for a loan without assistance from a co-signer. If you have a low credit score and manage to get approved for credit, your interest rate will be much higher than someone who had a good credit score. So, having a high credit score will save you many thousands of dollars in interest costs.


What Is A Credit Bureau?

A credit bureau is a company that collects and maintains your credit information and sells it to lenders, creditors, and consumers in the form of a credit report. There are dozens of credit bureaus, but the big three are: Equifax, Experian, and TransUnion.

How Credit Bureaus Determine your Credit Score

Credit scores provided by the three major credit bureaus -- Equifax, Experian, and TransUnion may vary because not all lenders and creditors report information to all three major credit bureaus. While many do report, others may report to two, one or none at all. In addition, the credit scoring models among the three major credit bureaus are different, as well as those used by other companies that provide credit scores, such as FICO.


The types of credit scores used by lenders and creditors may vary based on their industry. For example, if you are buying a car, an auto lender might use a credit score that places more emphasis on your payment history when it comes to auto loans. In addition, lenders may also use a blended credit score from the three major credit bureaus.

In general, here are the factors considered in credit scoring calculations. Depending on the scoring model used, the weight each factor carries as far as impacting a credit score may vary.

• The number of accounts you have

• The types of accounts

• Your used credit vs. your available credit

• The length of your credit history

• Your payment history


Here is a general breakdown of the factors credit scoring models consider, keeping in mind there are many different credit scoring models.

1. Payment history

When a lender or creditor looks at your credit report, a key question they are trying to answer is, “If I extend this person credit, will they pay it back and pay it back on time?” One of the things they will take into consideration is your payment history – how you have repaid your credit in the past. Your payment history may include credit cards, retail department store cards, installment loans, auto loans, student loans, finance company accounts, mortgage loans and home equity loans.


Payment history will also show a lender or creditor details on late or missed payments, bankruptcies, and collection information. Credit scoring models generally look at how late your payments were, how much was owed, and how recently and how often you missed a payment. Your credit history will also detail how many of your credit accounts have been delinquent in relation to all of your accounts in your credit file. If you have 10 credit accounts, and you have had a late payment on 5 of those accounts, that ratio may have an impact on your credit score. Your payment history also includes details on bankruptcies, foreclosures, wage attachments and any accounts that have been reported to collection agencies. Generally speaking, credit scoring models will consider all of this information, which is why the payment history section may have a big impact in determining some credit scores.


2. Used credit vs. available credit

Another factor lenders and creditors look at is your available credit vs the credit limit on your credit cards. Lenders and creditors like to see that you are responsibly able to use credit and pay it off, regularly. If you have a mix of credit accounts that are at their limit, this may negatively impact your credit scores.


3. Type of credit used

Credit score calculations may also consider the different types of credit accounts you have, including revolving debt (such as credit cards), the type of credit cards used (major credit cards vs department store credit cards) and installment loans (such as mortgages, home equity loans, auto loans, student loans and personal loans). The type of personal loans used may have an impact on your credit scores as well (bank loans vs finance company loans). Another factor is how many of each type of accounts you have. Lenders and creditors like to see that you are able to manage multiple accounts of different types and credit scoring models may reflect this.


4. New credit

Credit score calculations may also consider how many new credit accounts you have recently opened. New accounts may impact the length of your credit history.


5. Length of credit history

This section of your credit history details how long different credit accounts have been open and active. Credit score calculations may consider both how long your oldest and most recent accounts have been open. Creditors like to see that you have a history of responsibly paying off and paying on time your credit accounts.


6. Hard inquiries

Hard inquiries occur when lenders and creditors check your credit in response to a credit application. A large number of hard inquiries can impact your credit score. However, if you are shopping for a new auto or mortgage loan or a new utility provider, the multiple inquiries are generally counted as one inquiry for a given period of time. That period of time may vary depending on the credit scoring model, but the period of time is typically from 14 to 45 days.


Credit score calculations do not consider requests a creditor has made for your credit report for a preapproved credit offer, or periodic reviews of your credit report by lenders and creditors where you have an existing credit account. Checking your personal credit score also does not affect your credit scores. These are known as soft inquiries.


How Your Behavior Is Evaluated in Your Credit Report:

• Do you pay your bills on time? Payment history is a major factor in credit scoring. If you have paid bills late, have collections or a bankruptcy, these events will not reflect well in your credit score.

• Do you have a long credit history? The longer your history of holding accounts, the more trusted you will be as a borrower.

• Have you applied for credit recently? If you have many recent inquiries, this can be construed as being negative by the bureaus. Only apply for credit when it is necessary.

• What is your outstanding debt? It is important to not use all your available credit. If all your credit cards are maxed out, your scores will reflect that you are not managing your debt wisely.


Credit Score Ranges And Their Meaning

800 and Higher (Excellent) With a credit score in this range, no lender should disapprove your loan application. Additionally, the APR (Annual Percentage Rate) on your credit cards or loans will be the lowest possible. Achieving this excellent credit rating not only requires financial knowledge and discipline, but also a good credit history. To achieve this excellent rating, you must also use a number of credit accounts on an ongoing monthly basis and always repay them ahead of time.


740 - 799 (Very Good) With this credit score range, you will enjoy good rates and should be approved for nearly any type of credit loan or personal loan, whether unsecured or secured.


670 - 739 (Good) This range is the average credit score. In this range approvals are likely, but the interest rates might be marginally higher. If you are thinking about a long-term loan such as a mortgage, try working to increase your credit score higher than 720 and you will be rewarded for your efforts by a lower interest rate.


580 - 669 (Fair) Depending on what kind of loan or credit you are applying for and your credit history, you might find that the rates you are quoted are not the best. That does not mean that you will not be approved but, certain restrictions will apply to the loan's terms.


500 - 579 (Poor) With a poor credit rating you may still get an unsecured personal loan and even a mortgage, but the terms and interest rates will not be very appealing. You will be required to pay more over a longer period because of the higher interest rates.


300 - 499 (Very Poor) With a score in this range you may get a loan but nothing even close to what you expect it to be. Some people with bad credit apply for loans to consolidate debt in search for a fresh start. However, if you decide to do that proceed cautiously. With a 500 credit score you need to make sure that you do not default on payments or you will be making your situation worse and might head towards bankruptcy, which is not what you want.


499 and Lower (Very Bad) If your score is in this range, you need serious assistance with how you handle your credit. You are making too many credit blunders and they will only get worse if you do not take positive action. If you are thinking of a loan (which will not be easy), the rates will be extremely high, and the terms will be very strict. We recommend that you fix your credit first before applying for a loan.


CREDIT SCORES

The three major bureaus: EQUIFAX, EXPERIAN, and TRANSUNION

The purpose of a credit score is for lenders to determine the likelihood that you will repay money you borrow. Therefore, the scoring algorithms looks to see that you are not overextended in credit card debt and living beyond your means. As a rule of thumb, maxing out your cards will lower your scores while showing that you have more available credit will increase your scores. Pro tip: If you are carrying high balances, a tip to increase to your score is to focus on paying your down your balances to below 25% of the available credit limit of each card and never spend any more than that, even if you pay the bill off in full each month.

How quickly will I see the changes? Credit card companies report your balances to the bureaus once per month (each on a different day) and your credit reports and scores at the credit monitoring company will only update once per month, therefore it can take up to two months to see this initiative begin to impact your scores. For this reason, it is important to understand that improving your credit scores takes time and a commitment to change your daily habits and the way you spent money. The good news is that the sooner you can do it, the sooner your scores will increase.


How You Can Improve Your Scores

1. Stop applying for credit (Each time you do so lowers your credit scores.)

2. Do not close any accounts (Closing accounts that have been opened a long time also lowers your credit scores.)

3. Pay your credit cards down to below 25% of the available credit line. This will make a huge positive impact on your credit scores.

4. Never spend more than 25% of the available credit line, even if you pay the balance off in full each month.

5. Pay your bills on time! One missed payment will lower your scores dramatically.