Your credit score really just measures the chance you’ll pay someone – essentially how much of a financial risk you are. They are used for everything from apply for a credit card or mortgage to getting auto insurance or even a job. A high score means (the credit agency thinks) you have a high chance of paying your bills/loans.
The FICO score, created by Fair Isaac Corp in 1958, is the leading credit score metric. Here’s what different scores mean:
|FICO Score Range||Chance of Default|
|600||1 in 15 (subprime)|
|< 720||1 in 189|
|780+||1 in 1365|
Fair Isaac’s website has an education section about credit scores and how to improve them, which is really useful, and a must-read.
Here are the components of your score:
- 35% payment history
- 30% amounts owed
- 15% length of credit history
- 10% new credit (lots of new accounts lowers your score)
- 10% types of credit used (not using multiple types lowers your score)
Seven Credit Score Truths
- Missed payments on even 1 card can cause increased interest rates on all of your cards
- “Installment” debt owed (e.g. mortgages, auto payments) does not reduce credit score
- Late mortgage or credit card payments and collection accounts (if paid up) can be removed from your credit report by calling the creditor (credit agencies cannot make these changes)
- Late payment history is removed from the credit report after 7 years
- In general, credit report inquiries drop your credit score – BUT, multiple queries within 30 days do not cause your score to drop (i.e. it’s not bad to shop around your mortgage)
- Paying off student loan doesn’t improve credit score if the loan is current
- Your highest credit balance (ever) is what matters, rather than max credit (your credit card limit) e.g. a credit card with a 30k limit, but the most you ever charged in a month was 5k, if you charge 5k again in another month it is considered “maxed out” at that point, since you never had a higher balance. The 30k means nothing.
Building Credit History (can’t get a credit card?)
Building credit can sometimes be a chicken-and-egg problem – you can’t get a credit card without credit history, but you can’t build credit history without a card! One of the best ways to improve your credit score is to have a long history of always paying off your debt on time. To start building your history, here’s some ways to get it going if you can’t otherwise get a card:
- Secured credit cards – you pay a certain balance up front, say $500, and then get a $500 limit. Doesn’t sound all that great, but it is if you can’t get a card elsewhere. Find one that will send your collateral back after a certain period of time.
- Local bank credit cards – often times local banks or credit unions are more willing to issue cards to ‘new’ chargers
Credit Score Optimization Strategies for Home Buyers
If your score is decent, little ups and downs caused by fluctuating credit card balances, new accounts, inquires, etc aren’t a big deal. But if you are shopping for a mortgage, your current credit score is very important because it affects an interest rate which can in turn affect your finances for another 30 years or so. You should do the following:
- Do not open or close accounts (including credit cards)
- Check your revolving accounts balance, keep it low
- Check your credit limits, and your highest balance (based on card history) – make sure cards (including Amex ‘charge cards’) have not been charged near their highest balance limits in the last 1-2 months
- Do not pay off accounts in collection
Remember that shopping around a mortgage doesn’t lower your score!
Fraud and ID Theft
Sometimes you can’t help it – wallets get stolen, cards get left a bars… most times you can just cancel the cards, kick yourself in the shin and get on with life. But if there are unauthorized charges, here’s what to do:
- File a police report (very important)
- File an affidavit with the creditor
- Get the creditor to delete your name from the account (reporting agency can’t help here)
If you are worried about future stolen cards or your credit report in general, you can use a credit score monitoring service – it costs money, but can be worth it if your credit is fragile. Check out myfico.com. Personally, I just order a report from one of the 3 agencies every 4 months on a rolling basis so I always have a pretty up-to-date view of my report.
Any rumors you’ve heard about cards? Stories about your credit? Leave it in the comments!