How to Understand Your Credit Score

Credit...everyone wants it and needs it in today's world, but some people seem to
get it more easily and with better payment terms than others. How come?

Credit scoring is used to help creditors evaluate your ability to repay home mortgage loans, car loans, credit card bills, and other financial obligations. If you've been wondering how lenders decide whether you should be given credit, it's time you get to know the credit scoring system that they use.

How Your Credit Score is Created

When you apply for credit, the lender collects details about you and your financial experiences from your credit application and from your credit report. Your credit score is reported as a 3-digit number that ranges from 300-900.

There are 5 factors that lenders use to calculate your credit score. As you'll see below, not all of the factors are weighed equally:
  • Timely payment of bills
  • 35%
  • Total credit balance vs. total credit available
  • 30%
  • Length of credit history
  • 15%
  • Newly opened accounts and/or applications
  • 10%
  • Ratio of credit cards to loans
  • 10%

Using a statistical program, creditors compare this information to the credit performance of consumers with similar profiles. If your FICO score is over 800, there is only a 1% chance that you will default on your loan. If your score is under 500, on the other hand, there is an 83% chance that you won't make your payments.

The most interesting thing, however, is that consumers with credit scores ranging from 600-649 are said to have a 31% chance of going into default. But, with just a tiny nudge into a score of 650-699, a consumer becomes a much more desirable risk, with only a 14% chance of defaulting!

Your credit report is an important part of many credit scoring systems, it is very important to make sure your score is accurate before you submit a credit application. To lenders, lower risk translates into lower interest and better terms for a loan or credit card.

An Imperfect System

Credit scoring systems make it possible for lenders to evaluate millions of applicants consistently and impartially based on many different characteristics. While you may consider the system is arbitrary or impersonal, scoring systems have their upside. Credit scores allow creditors to make lending decisions faster...and that means consumers get their money faster!

Even people who 'bum' credit are helped by credit scoring systems. Many creditors design their systems so that in marginal cases, applicants whose scores are not high enough to pass easily or are low enough to fail absolutely are referred to a credit manager, who decides whether the company or lender will extend credit.

So despite its appearance, credit card scoring does open the door for discussion and negotiation between a lender and the consumer.

And Credit for All

Subjective methods for determining credit 'worthiness typically rely on criteria that are not systematically tested and can vary when applied by different individuals. That's why credit scoring is based on real data and statistics. It is more reliable than subjective or judgmental methods.

Credit scoring treats all applicants objectively...by law

The Equal Credit Opportunity Act was passed to ensure that no credit scoring system discriminates against a consumer by using race, sex, marital status, national origin or religion as factors for determining credit.

It's interesting to note, however, that lenders can factor in age in properly designed scoring systems, although any scoring system that includes age must give equal treatment to elderly applicants.

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The 5 Factors that Affect Credit Scores

Credit scoring models generally evaluate the following types of information in your credit report:

  1. Timely Payments

  2. Payment history typically is generally the most significant factor. Your score will dip if you have:
    • Paid bills late
    • Paid less than the minimum
    • Had an account referred to collections
    • Declared bankruptcy
  3. Outstanding Debt

  4. Credit scoring models factor in the amount of debt you have compared to your credit limits. If all your credit cards are maxed-out or you don't have a lot of equity in your mortgage, it is likely to have a negative effect on your score.
  5. Credit 'Track Record'

  6. Credit scoring models generally factor in the length of time that you have had and used credit. A history of zero borrowing-and-repaying will surprisingly give you a bad, not a good score. However, this can be offset by other factors, such as timely payments and low balances.
  7. Number and Types of Credit Accounts

  8. Although your score is helped by established credit, too many credit card accounts will have the opposite effect. In addition, many models consider the type of credit accounts you have. For example, under some scoring models, loans from finance companies may negatively affect your credit score.
  9. Recent Credit Applications

Credit scoring models consider how active you've been in accumulating credit. If you have applied for a large number of new accounts, it can negatively affect your score for as long as two years, since that's how long the inquiries will stay on your record.

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How to Improve Your Credit Score in 6 Steps

Unless you're one of those lucky people with a credit score of 800 or higher, chances are you'd like to improve your score and enjoy the benefits that come with having a better rating.

6 Steps to Improving Your Score

It's surprising how few people know their credit score. We often don't realize we want a good credit score until we need it... and then it's too late. You don't want to be sitting across from the salesman at the auto dealership and suddenly learn that your poor rating means you're going to pay higher interest for your auto loan.

Your credit history is your strongest argument for assuring lenders that you're a good credit risk. So it's wise to take these 6 steps to build the best credit record you can... before you need to ask someone for a loan.

Step #1: Pay on Time, Every Time
More than one-third of your credit score (35%), is determined by your payment history. Do you always pay your bills? If you do pay them, are they on time, or do you consistently incur late fees?

Paying your bills on time will avoid costly late fees and will eventually help increase your credit score.

Step #2: Pay Down ALL of Your Balances
Approximately one-third of your credit score (30%), is determined by the ratio of money you owe (your balances) to the credit that is available to you (your credit limit). In other words, if you are carrying high balances on many cards, it has a very negative impact.

Paying down debt so that you are carrying credit balances that are at or less than 25% - 30% of your account limits is ideal. For example, a $250 balance on a card with a $1,000 limit will have a fast and positive impact on your score.

Step #3: If You Don't Have Credit...Get it NOW
Contrary to what you may think, it is not a good idea to have zero credit since 15% of your credit score is determined by the length of your credit history.

The past is considered a great predictor of the future, so a consumer who has borrowed and repaid loans and debts consistently over a 12-month period is a better risk than someone who has no credit record whatsoever.

Step #4: Don't Go Credit Card Crazy
It seems like every time you go to pay for a purchase these days, someone is offering you a credit card. Remember that 10% of your credit score is based off of the number of times you have applied for credit. It doesn't matter if you have never used the cards or even been approved!

The more cards and loans you have, or have applied for, the more credit report inquiries will show up on your credit report. Why do inquiries matter? A higher number of credit report inquiries are a 'red flag' to creditors that you're struggling financially or may have a lot of debt. All inquiries remain for a minimum of 1 year from the date the inquiry was made, and most inquiries will stay on your credit history for 2 years. Therefore, the more times your credit is 'run' the more negative the impact on your credit score.

Step #5: Diversify Your Credit
10% of your credit score is determined by the variety of different types of credit accounts you have. Your score is based upon whether you have:
  • Credit cards
  • Retail accounts
  • Installment loans
  • Finance company accounts
  • Mortgage loans

A variety of loans and credit arrangements demonstrates that you are able and committed to pay all different types of accounts.

Step #6: Monitor Your Account Like a Hawk
We don't live in a perfect world, and credit scoring is a far from perfect process. Fortunately, under the Fair Credit Reporting Act, you're entitled to one free credit report each year so your fact-finding mission doesn't have to cost you (meaning that the inquiries you make do not show up on your credit report nor will they affect your credit scores).

It is important to monitor all three credit bureaus because the information contained in one company's records may not coincide with information contained in the others'. If you discover an inaccuracy has occurred, you have the right to dispute these errors and have them corrected or removed all together.

You'll need documentation to make your case, so be sure to keep copies of all paperwork related to any loans, mortgages, or credit cards you may have.

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What to Do if You Are Denied Credit

Don't take 'no' for an answer. Indefinite and vague reasons for denial are illegal, so ask the creditor to be specific. This isn't just a good idea...it's your legal right.

If you are denied credit, the Equal Credit Opportunity Act mandates that you must be told the specific reasons your application was rejected and that you have the right to learn the reasons as long as you ask within 60 days.

Acceptable reasons include:
  • "Your income level is insufficient"
  • "Your accounts are maxed-out"
  • "You have not been employed for a long enough period of time"

Unacceptable reasons include:
  • 'You don't meet our standards'
  • 'We didn't like what we saw on your report'
  • 'Your application didn't receive enough points in our scoring system'

If a creditor has denied your application because you are near your credit limits on your charge cards or you have too many credit card accounts, you may want to reapply after paying down your balances or closing some accounts. Keep in mind that credit scoring systems are not set in stone. They factor in updated information and change over time.

Sometimes you can be denied credit because of information from a credit report. You have the right to find out what that information was and how it was used, and the U.S. government is on your side.

The Fair Credit Reporting Act requires that the creditor to give you the name, address and phone number of the credit reporting agency that supplied the information used to review your application. You can then contact that agency and ask to see what was supplied. By law, this information is free if you request it within 60 days of being denied credit.

Note: The credit reporting agency can give you the data that is in your credit report, but only the lender/creditor can tell you why your application was denied.

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How to Dispute and Correct Credit Report Errors

8 Steps to Repairing Your Credit

The eight steps below are an effective how-to guide on what it takes to repair a credit report error, and what you should do and/or be careful of during the process.

The #1: Don't Let Fear Stand in Your Way
Many people find dealing with financial issues absolutely terrifying. They are nervous or feel uneasy about handling credit report information alone. Instead, they do nothing and become the victims of bad credit.

It doesn't have to be that way. There are non-profit companies in most areas, as well as paid professionals that can help you understand the information on your credit report. More importantly, they can advise you and help guide you in the decisions about which errors you can and should dispute.

Step #2: ABP (Always Be Prepared)
If you don't have current copies of your credit report, visit www.AnnualCreditReport.com and request your credit report from all three credit reporting agencies. You may have to request more than once.

Keep in mind that credit reporting agencies are for-profit companies, so don't expect them to want to help you out of the goodness of their corporate hearts. Stand up for your rights. A free copy of your credit report is your legal right.

Step #3: Write a Letter...or 2 or 3
If you should discover any mistakes on your credit reports, run, don't walk to contact the credit reporting companies right away. It's critical that you dispute credit report errors as soon as they are uncovered. If you delay, it will become more difficult to remove the erroneous information, which in turn will continue to cause your problems with your credit.

If the same error appears on the reports of more than one agency, be sure to contact each reporting agency individually. They don't necessarily exchange information.

Step #4: Send Documentation, but Not Originals
To file a dispute with a credit reporting agency, you'll need to provide documentation that supports your claim. Don't make the mistake of mailing original documents such as the original credit report or your original credit statements.

You need to hold on to the originals for your own file so that you can make clear, legible copies in the future, if requested.

Step #5: Enlist the Post Office
Another piece of advice for protection is to always send items via registered mail. This will ensure the letter gets to them, and there is a tracking number for your own records.

Step #6: Contact Creditors
Depending on the item in error, consider contacting the creditor directly to see if their system was the source of the error. So much information is handled via automated systems these days, that a small error such as an incorrectly keyed social security number can trigger the wrong report.

If that's the case, you should ask that your creditors contact the credit bureaus to resolve issues as well, and ensure that the credit report error is deleted.

Step #7: Know the Process
After a credit bureau receives your dispute credit report error, they have approximately 30 days to investigate. The credit bureaus will attempt to prove that the item is not an error. If this cannot be done, then the item should be deleted. Understanding how the credit report dispute process works will help you wait patiently, and supply supporting arguments if need be.

Step #8: Get Lawyer-ed Up
Identify theft and other situations may make credit repair issues more difficult to resolve. Fortunately, there are credit repair lawyers that can help you draft credit dispute letters and handle your case if needed. If you prefer the idea of handing over the case to someone or would simply like to discuss your options, consider seeking out a lawyer who specializes in credit report disputes.

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Guide to Consumer Credit

Credit is a necessity of life for purchasing a home, purchasing a vehicle or getting credit cards. But did you know there's more to credit than that? Your credit, and more importantly your credit score, can impact your...
  • Insurance rates
  • Qualification for a new job or promotion
  • Bank memberships
  • Apartment rentals
  • Cellular phone services
  • Cable TV services

The Relationship between 'Credit' and 'Credit Score'

You are granted 'credit' when a company or individual makes a sum available for you to borrow. There are two main types of credit extended to consumers:
  • Credit that is linked to a specific item or items ' for example, a new kitchen, or a house (home improvement loans and mortgages)
  • Revolving credit on payment cards that provides access to a fixed amount of money that you can spend as you wish, in a wide range of retailers and other outlets

Your 'credit score' is a 3-digit number that is calculated based upon factors in your credit history. Your credit score predicts whether you're a good risk for re-paying a new credit obligation. It is used by lenders to determine the interest rates on loans and credit cards.

It is a VERY important number.

There are three major credit reporting agencies:

  • Equifax
  • www.equifax.com
    P.O. Box 740241
    Atlanta GA, 30374-0241
    (800) 685-1111
  • Experian (formerly TRW)
  • www.experiean.com
    701 Experian Parkway
    P.O. Box 2002
    Allen, TX 75013
    (888) 397-3742
  • TransUnion
  • www.transunion.com
    2 Baldwin Place
    P.O. Box 1000
    Chester, PA 19022

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Where to Get Your Credit Report and Credit Score

Get Yours

You can't manage what you don't know. To get copies of your credit report, contact the three major credit reporting agencies. You are entitled by law to one free report each year. Beyond that, you may be charged as much as $9 per copy.
  • Equifax
  • www.equifax.com
    P.O. Box 740241
    Atlanta GA, 30374-0241
    (800) 685-1111

  • Experian (formerly TRW)
  • www.experiean.com
    701 Experian Parkway
    P.O. Box 2002
    Allen, TX 75013
    (888) 397-3742

  • TransUnion
  • www.transunion.com
    2 Baldwin Place
    P.O. Box 1000
    Chester, PA 19022
    (800) 916-8800

Remember, credit scoring systems are complex and sometimes unique to a specific creditor. For example, one store may rely on information from Equifax, while another trusts Experian, and a third store tallies reporting data TransUnion...or even all three reporting agencies.

Only the specific creditor can explain what might improve your score under the particular model that business uses.

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Guide to Reading a Credit Report

A credit report is basically divided into four sections

Section #1: Identifying Information
This section provides the basic information that identifies you as an individual:
  • Name
  • Social security number
  • Date of birth
  • Current address
  • Previous addresses
  • Telephone numbers
  • Occupation
  • Employer
  • Spouse's Name

Section #2: Trade Lines (or Credit History)
This section shows the details of each credit account you currently have including:
  • When you opened the account
  • The kind of credit (installment: such as a mortgage or car loan, or revolving: such as a department store credit card)
  • Whether the account is in your name alone or with another person
  • The total amount of the loan, high credit limit or highest balance on the card
  • How much you still owe
  • Fixed monthly payments or minimum monthly amount
  • Status of the account (open, inactive, closed, paid, etc.)
  • How well you've paid the account

Section #3: Public Records
The public records section contains information on your credit comings-and-goings that are found in documents available to the public, generally in documents filed in the court system. Public records include:
  • Accounts in Collection:
    A collection account ranges from a delinquent trade line account, unpaid medical bills, unpaid utility balances, unpaid cell phone bills, etc. Collection accounts will stay on your credit report for 7 years from the original delinquency date.
  • Bankruptcy:
    Bankruptcies that were filed under chapter 7, 11, or 12 will stay on your credit report for 10 years from the date filed. Chapter 13 bankruptcies will stay on your credit 7 years from the date filed. Any account included in bankruptcy will show 'included in bankruptcy' for 7 years from the date filed.
  • Judgments:

  • Judgments (including civil, spousal support, and even small claims judgments) will generally stay on your credit history for 7 years. However, since some judgments (such as child support) are renewable, they can remain on your credit report a very long time. Once paid it would be listed as 'satisfied' and be expunged after 7 years expired.
  • City, State, Federal, or County Tax Liens (city, county, state or Federal):

  • Unpaid tax liens will show on your credit for 15 years from the filing date. Satisfied or released tax liens will show on your credit for 7 years from the date the lien was paid in full.
  • Delinquencies:

  • Payments made anywhere from 30'180 days late will stay on your credit report for 7 years from the original delinquency date.
  • Outstanding Debts:

  • The more credit cards you have that are maxed out, the lower your score will be. (As mentioned above, try to keep your credit card balances at 25 % or less of your limits)
  • Lost or Stolen Credit Cards:

  • Any delinquent payments that happened prior to the report of your card being lost or stolen will remain as part of your credit history for 7 years. If the account has never been delinquent and paid as agreed, the credit card reported lost or stolen will remain on your credit for 2 years from the date it was reported stolen.
  • Accounts Paid as Agreed:

  • Any trade line account in good standing which was paid as agreed will stay on your credit for 10 years.
  • Charge Offs:

Trade lines that were charged off by the creditor will stay on your credit for 7 years from the date of the original delinquency.

Section #4: Inquiries A credit inquiry is an item on a credit report that shows a business with a "permissible purpose" (as defined under the federal Fair Credit Reporting Act) has previously requested a copy of the report. The inquiries section of your credit report contains a list of everyone who has accessed your credit report within the last two years.

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