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Credit is crucial today in how we all live and manage our money. And an important part of obtaining credit is your credit score. Simsbury Bank and other lenders use credit scores at least in part to determine whether to extend a person credit, how much to extend and at what interest rate. Learn more about this important facet of financial life.
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What is a credit score?
A credit score is a number based on a mathematical formula developed by Fair Isaac Corp. This number is sometimes called the FICO Score®. These credit scores range from 300 to 850. The higher your score, the better. There are other credit scores, but the FICO Score®
is the most commonly used, is used by Simsbury Bank, and what will be discussed here.
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What is a good score?
That depends on the lender and the purpose of the loan. Some lenders may offer their best interest rates to borrowers with credits scores of 680 and over, some may reserve their best rates for those with scores of 720 and above. Your lender can give you guidance on their criteria.
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Generally, what goes into a credit score?
All of your credit accounts are continuously reviewed by credit reporting agencies. Credit accounts include mortgages, car loans, credit cards, medical bills, parking tickets and more. Your payment history is key among the factors considered. Late payments, missed payments and settlements will mean a lower score. The score is a snapshot of your credit report at a particular point in time. The report details your credit history as it has been reported to the credit reporting agency by lenders who have extended you credit. The length of time your accounts have been open – that is, a lot of newer accounts will lower your score.
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Specifically, how are scores derived?
There are five parts to the equation that generate your credit score.
35% of the score is based on your payment history. This includes payments to credit card companies, retail accounts, installment loans (such as car loans), finance company loans and mortgages. Included in the payment history calculation are public records and collection items including bankruptcies, foreclosures, suits, wage attachments, liens and judgments. Bankruptcies will stay on your report for 7 to 10 years, depending on the type. Regarding late payments, the score considers how late they were, how much was owed, and how many there are. For example, a 60 day late payment is less serious than a 90 day late payment. But, recentness also counts meaning that a 60 day late payment last month counts more than a 90 day late payment from 5 years ago.
30% is based on the amount you owe to each creditor compared to your total availability. The higher your percentage of available credit that has already been used, the lower your score because this can indicate a person who is in jeopardy of becoming overextended. The credit score takes into account the amount you owe on all of your accounts (even if you pay off your credit cards in full each month, your report may show a balance from the specific date the credit report was pulled). Also taken into consideration is how many accounts have balances – the larger the number, the higher risk of overextension. But, closing unused credit accounts that have zero balances and that are in good standing will not improve your score. Also important to your score is how much you owe on installment loan accounts compared with the original loan amounts – the more you have paid down to the original loan, the better it appears you are able and willing to manage and repay debt.
15% is based on the length of your credit history, both how long you have had an account and how long since you had activity with that account. If you have only been managing credit for a short time, don’t open a lot of new accounts too rapidly. The score takes into account how long you have had credit accounts in general, how long specific accounts have been established and how long it has been since you used certain accounts.
10% is based on how many accounts you have opened recently compared to your total number of accounts. Opening several accounts in a short period of time represents a greater risk of future over-extension and non-repayment, especially for people who are new to managing credit. However, the score takes into account the difference between rate shopping for the best mortgage or auto loan versus opening new accounts. So, do your rate shopping for an auto or mortgage loan within a short period of time, say two weeks. Open new accounts carefully, only opening those you need.
10% is based on the type of credit you use. The credit mix usually won’t be a key factor in determining your score, but it will be more important if your credit report does not have a lot of other information on which to base a score. The credit score takes into account if you have experience with both revolving and installment type accounts versus just one of those types, as well as the total number of credit accounts you have.
There must be enough credit information, and recent enough information, for the agencies to determine a score – that usually means at least one account that has been open for six months or longer and at least one account that has been reported to the credit reporting agency within the last six months. The score derived is based on the information contained in your credit report at each of the three main reporting agencies. If one agency has different information about you, that would affect its score on you.
Older credit problems count for less. So, if you have had poor credit performance in the past, the impacts of those instances will affect you less and less as time passes and good payment patterns show up on your credit report. But, these changes take time and usually don’t change much from month to month. A bankruptcy or late payment can hurt your score faster than good payment history will repair it.
The last two years of credit inquiries are listed in the credit report and include “voluntary” inquiries (inquiries that are prompted when you apply for credit on your own), and “involuntary” inquiries (for example, when a lender orders your report before making you a preapproved credit offer in the mail).
The score is a compilation of what is in your credit report – the scoring agencies do not determine the accuracy of what is in your credit report. You should periodically (annually is suggested) get a free copy of your credit report through the three main credit reporting agencies listed elsewhere in this article.
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What do lenders do with credit scores?
Lenders purchase credit scores from the three agencies and use them to make billions of credit decisions every year. They make decisions about whether to lend you money, how much to lend you and at what rate to charge you on a loan, whether you are applying for a credit card, a car loan, a personal loan or a mortgage. Some lenders – often credit card companies – almost exclusively use your credit score – and could decline you or charge you a higher rate simply from the score. Because of the broad use of credit scores today, some credit decisions are made much more quickly than they were many years ago, some almost instantaneously. Some retail stores, internet sites and other lenders make “instant credit” decisions based on the score.
However, a credit score does not guarantee whether an individual customer will be a “good” or a “bad” customer. There is no single “cut off” score used by all lenders that indicates a “good” risk from a “bad” risk. And, while many lenders, including Simsbury Bank, use credit scoring as a part of their lending decisions, it is not the only factor.
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Who else uses credit scores?
Employers may use a version of your credit report, called a PEER report, in its determination of whether to hire you. If you are declined in whole or in part because of your credit report, you have certain rights which should be explained by the employer. The PEER credit report does not include a credit score, however.
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How does credit score affect mortgage loans?
Fannie Mae and Freddi Mac charge more for loans to borrowers with lower credit scores. The rates and fees vary depending on each borrower’s situation. For example, a lower down payment percentage might require a higher credit score to obtain a better interest rate.
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How can I find out my credit score?
By law, the three credit reporting agencies, Equifax, Experian, TransUnion, must provide you with a free copy of your credit report once a year. (see section below) However, the free credit report only lists the credit accounts you have, not the FICO score. Agencies usually charge you a fee to share your credit score with you. Remember that your FICO score, because it is based on the information in each agencies’ files, which may be different, might vary between the three agencies.
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Why Should I Find Out What My Credit Score Is?
Six months before making a major purchase is a good time to check your credit report and credit score. This will give you time to verify the information on your credit report, correct any errors if any and take action to improve your score if necessary. The cost savings on having a good credit score can be significant as lenders charge different interest rates depending on your score.
If you opt for paying for an agency sharing your credit score with you, be sure the score included is the FICO® score. Other scores are available, but the FICO® is the one that most lenders use.
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What if there is an error in my credit report?
It is critical that you look at your credit report when looking at your credit score as the score is directly related to what is reported in the credit report. You can dispute any errors by contacting the three agencies. If you report an error to a credit reporting agency, it must investigate and respond to you within 30 days. If you are in the process of applying for a loan, immediately notify your lender of any incorrect information in your report.
For more information, contact the Annual Credit Report Request Service at:
P.O. Box 105281
Atlanta, GA 30348-5281
1.877.FACT ACT (1.877.322.8228)
www.annualcreditreport.com
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What is not in my credit score?
Factors such as gender race, religion, nationality, marital status, age, salary, occupation, employer, employment history, where you live, interest rates charged, child/family support payments or rental agreements are not considered in the calculation of credit scores.
Updated information, such as a new address, come from lenders when you supply it to them. Your name, address, Social Security number, date of birth and employment information are used to identify you, but these factors are not used in calculating your score.
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The impact of Inquiries on Your Score
For most people, one credit inquiry will have little impact, perhaps 5 points or so, on their score. However, six or more inquiries in one year may reduce your score. Remember that checking your own score, as long as you go through the credit reporting agencies directly, or an agency that provides this information to consumers, will not impact your score. Also, pre-authorization inquiries, such as those performed by companies before they send you un-solicited credit card offers, do not impact your score (even though you may see them listed on the report). And, inquiries from employers are not counted against your score. Rate shopping, if it is done in a short amount of time, for example, within 14 days, will not hurt your score.
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Tips for Improving A Bad Score or Maintaining A Good Score
- Pay your bills on time.
If you missed payments, get current and stay current.
- Be aware that paying off a collection account, or closing an account on which you previously missed a payments, will not remove it from your credit report. Over time, these will impact your score less, but they do not disappear from impacting you when you pay them off.
- If you are having trouble making ends meet, contact your creditors or see a legitimate credit counselor. Again, making progress on your difficult bills won’t immediately change your score, but your score should get better over time. Seeking assistance from a legitimate credit counseling service will not hurt your score.
- Keep balances low on credit cards and other revolving credit.
- Pay off debt rather than moving it around. The most effective way to improve your score in this area is to pay down your revolving debt.
- Don’t close unused credit cards as a short-term strategy to raise your score. If your outstanding balance remains the same, having fewer accounts may actually lower your score. And, closing old accounts with poor payment histories does not make those histories go away. You may have other reasons to close unused accounts, but raising your credit score is not one of them.
- Don’t open accounts you don’t need. That new store credit card that gives you 15% off your first purchase might end up hurting your credit score because of the additional credit it offers you.
- Avoid credit repair agencies that charge a fee to improve your score. These agencies can not control what remains in your credit report – only reporting agencies or lenders can remove inaccurate information – and you may end up paying an agency a fee without their being able to change your score.
- Have credit cards, but manage them responsibly. In general, having credit cards and installment loans and making timely payments will raise your score. People with no credit cards, for example, tend to be higher risk than people who have managed credit cards responsibly.
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What if I am turned down for credit?
The Equal Credit Opportunity Act (ECOA) gives you the right to obtain the reasons why within 30 days. You are also entitled to a free copy of your credit report within 60 days, which you request from the credit reporting agencies. If your credit score was a primary part of the lender’s decision, the lender may use the “key factors” of the score reasons to explain their decision. These key factors are provided by the credit reporting agency and your lender can relay them to you. While these reasons may not help you with the credit you were turned down for, and for some there is little you can do about (such as having a short length of credit history) the reasons can help you understand what you need to do to increase your score in the future. For more information on your score and how you can improve it, go to www.myfico.com/crediteducation.
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