Financial Planning Highlight
Credit Scores and Credit Reports ... the straight scoop
How do companies evaluate my credit?
To start it is important to distinguish between your credit score and your credit report. A credit report is a history of your credit accounts and your payment history for those accounts. Your credit score is a number calculated by a company called Fair Isaac based on your credit report. There are three big credit reporting companies, Equifax, Experian and TransUnion and you will have a credit score for each of those companies. Your credit score can vary for each reporting company because the information each company has about you will vary to some degree.
You will have to pay to get a copy of your credit score. Obtaining credit scores is not necessary for most people (unless ther is fear of identity theft) but the following calculator will estimate your score based on the information from your credit report.
While the actual formulation of your credit score is proprietary, the factors involved are:
- 35% on how regularly you pay your bills on time
- 30% on the amount you owe and percentage of your total available credit you are using
- 15% on how long your credit history is
- 10% on how many new credit accounts you have opened
- 10% on the types of credit you have (for example, credit card versus mortgage)
How your credit score affects your life.. and your wallet.
Your credit score will determine the interest rate you are charged on nearly any credit account, from your mortgage to your, ehem, Bloomingdale's credit card. For example, the payment for a 30 year, $300,000 loan from one of the largest U.S. banks for an individual with a 690 score is nearly $100 more than the same person with a score of 765. If the score was below 660, they would not even be eligible for a thirty year loan without further underwriting by the bank.
Credit scores are not just for the issuance of credit lines. It has become nearly a standard practice for landlords to vet potential renters by checking their score. The rates most auto insurance companies charge is partly based on your score and many employers factor your credit report (if not the score) into hiring decisions.
How to Maintain Your Credit Score
The first step is to make sure that your credit reports are accurate. You can get a free copy of your report (not your score) from each of the major reporting agencies once a year at www.annualcreditreport.com . Review the report for any inaccuracies such as accounts that do not belong to you, reported missing payments that you have made, and contact the agency to correct any mistake.
Assuming all information on your report is correct, the best ways to maintain, or improve your score are:
- Pay all your bills on time. This is the most important factor. We have seen a credit score knocked down by 100 points over late payment on a $125 bill.
- Do not utilize all of your available credit. While you may think it looks prudent to maintain a credit card with a low credit limit to ensure you do not overindebt yourself, the credit agencies see you as someone who nearly maxes out your cards every month. It is also not a good idea to maintain a balance that rolls over month to month.
- For purposes of your credit score it is important to have some kind of credit history, even if you do not need the credit. You will find it surprisingly difficult to get a mortgage if the bank can find no payment history of any type when they look at your report.
- Do not open a lot of new credit accounts. You may get offers from every store you shop to open an account but that will be viewed negatively when your score is calculated. When it comes to your credit score, the fewer, older and underutilized your credit lines are the better.
We recommend you review your credit report once a year to ensure accuracy. If you are entering a transaction where your credit is an important factor, such as buying a home, you should do so more frequently. We have seen home closings delayed by information that appears on a credit report in the time between when the purchaser started looking and when they are ready to close.
As always we welcome your comments or suggestions. Stop in to see us at 420 Lexington Ave, Suite 2920, New York, NY... Call us at 212.949.0494 or simply 'reply' to this email.
Thank-you for reading,
John O'Meara, CFP®
Michael Keating, CFP®