If you had to choose between disclosing your weight or your credit score on Facebook, which would you choose? If you're like 70 percent of Americans, you'd rather keep your credit score to yourself. Sometimes, what you'd assume would be good for your credit can actually work against it and. Learning the ins and outs of credit scoring can make a big difference in your time and money.
A credit score is the numerical value calculated from information in your credit file that is used by lenders and landlords to assess your “credit risk” at that time. A credit report is a summary of your financial reliability—for the most part, your history of paying debts and other bills.
If your entire financial life could be boiled down to one number, it would be your credit score. It's a three-digit figure that represents your history of borrowing and paying back money. The higher the score, the more trustworthy you're considered to be by creditors.
A poor credit score could mean paying sky-high interest rates on credit cards and loans (if you're approved at all). Having a high credit score means borrowing money at the lowest rates available. You don't have to worry about losing out or paying more because you appear financially irresponsible. A higher credit score can save you thousands of dollars over the long run and make your life easier,
The three major credit bureaus, Experian, Equifax and TransUnion , collect your personal and financial information and compile it all into your credit report. Credit reports detail personally identifying information such as your name, address and Social Security number, open and closed credit card accounts, loans, bills in collections, liens, and bankruptcies.
You're entitled to a free credit report from each of the three major bureaus every year through AnnualCreditReport.com, the only site federally authorized to provide free credit reports. Here are ways you may be surprised to learn about credit scores that you can use to your advantage.
1. A healthy mix of
credit accounts is important:
While it's not one of the larger categories, 10% of your Fair Isaac Corporation
(FICO) score is made up of your "credit mix." In other words, if you
have a credit card account, an auto loan, a mortgage, a student loan, and a
store credit account, then your score could be better than it would be if you
just had a couple of those.
The reasoning behind this is that
a broad credit mix shows lenders that you can be responsible with all kinds of
credit not just credit cards for example. To be clear, I'm not saying you
should run out and finance a new car just to improve your credit. The point is that
if you only have credit cards and no other type of credit accounts, then your
score could hit a plateau below 850.
2. Carrying a small
credit card balance can help:
While your credit utilization is a big part of your score, and lower is better,
it can actually hurt you to carry a zero balance on all of your credit accounts. The
exact FICO formula is a closely guarded secret, but in 2014 I had a
conversation with one individual who seemed to have cracked the code. David
Howe, who simultaneously achieved perfect 850 FICO scores from all three bureaus, told me that in order to
achieve a perfect score, you must have one active revolving credit
account with a small balance.
In fact, in one situation his
score dropped by 25 points simply because he paid off a small credit card
balance. I'm not saying you should carry a large balance; about 1% of your
credit limit should do it. The point is that lenders want to see that you're
using your credit and doing so responsibly.
3. Closing your old
credit cards can hurt your score:
30% of your FICO score comes from a category of information called
"amounts owed." While a lot of information goes into this category,
the most important figure is your outstanding debt relative to your available
credit. For example, if you owe $1,000 on credit cards and have a total credit
limit of $5,000, then you're using 20% of your available credit.
On the other hand, if you owe
$4,000, but have $40,000 in credit limits, then you're only using 10%, which is
looked upon more favorably, even though the dollar amount you owe is four times
as much. Closing an old credit card that you no longer use can cause your score
to drop, as it reduces the amount of available (unused) credit you have. If you have a $1,000 balance and a credit
limit of $5,000, your credit utilization will jump from 20% to 25% if you close
an unused card with a $1,000 limit.
4. Not all scores are
the same: There are several varieties of
credit scores out there. Unless you're looking at your FICO credit score,
you're probably not seeing what your lender is going to see. This is especially
important to know, as many "free credit score" websites use other
scoring models, such as the Vantage score, which is a distant second in
popularity.
The FICO score is used in more
than 90% of lending decisions so that's the one to know. Furthermore, there are
several variations of the FICO score. Each of the three major credit bureaus'
credit reports will produce their own scores, and they can differ considerably,
even with almost identical credit information. Even if your credit card issuer provides you
with free access to your FICO score, it generally comes from just one of the
three bureaus.
5. You can apply for as
many mortgages or car loans as you want:
One little-known provision in the FICO formula is specifically designed to
encourage you to find the best credit deals possible by shopping around for the
lowest interest rates. It’s common knowledge that allowing your credit to be
checked by lenders is not a good thing. When a creditor checks your score, it
can cause your FICO score to drop by a few points, as this affects the
"new credit" category that makes up 10% of your score.
If you're shopping for a mortgage
or auto loan, then as long as all your credit pulls are completed within a
"normal shopping period," it will count as a single inquiry for
scoring purposes. In other words, if you're shopping for a mortgage and fill
out a pre-approval application with 20 different lenders, then your credit
score will only reflect one of them.
A normal shopping period is
either 14 or 45 days, depending on which version of the FICO formula you're
looking at so try to keep all of your applications to a 14-day window, just to
be safe. Even a small difference in interest rates can mean thousands of
dollars in savings so take advantage of this benefit.
“A person’s credit report is one
of the most important tools consumers can use to maintain their financial
security and credit rating, but for so long many did not know how to obtain
one, or what to do with the information it provided.”
(Ruben Hinojosa)[i]
[i] Sources used:
·
“5 Things You Didn't Know About Your Credit Score”
by Matthew Frankel
·
“Break the Code” by
WhatsMyScore.org
·
“Everything You Need to Know About Credit
Scores” by Casey Bond
·
“FICO” from Wikipedia
Inspired by a Credit
Karma commercial
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