Dated:February 2009
Have ever been turned down for a credit card or a loan? Charged a higher APR or increased mortgage payments? The reason can be obvious: your bad credit score. It affects whether you can get credit and how much you will pay for credit cards, loans or mortgages. A bad credit score also leads to restrictions in other aspects of life, including the ability to rent an apartment and get a job. That’s why knowing and understanding your credit rating is a necessary part of your financial health.
Credit score reflects your borrowing activity and payment pattern in the past. Lenders don’t grant credit as a matter of course. It is similar to lending money to a stranger! They use credit scores to evaluate your financial responsibility and predict whether you can make your payments on time or not.
There are several types of credit scores. They are developed by credit bureaus, independent companies and even some lenders. However, the most popular credit scoring system is a FICO score, developed by Fair Isaac Corporation in 1989. It is used by lots of credit companies as an objective measure of applicants’ creditworthiness.
Generally, FICO score ranges from 0 to 850. The more points you have, the better. FICO scores above 660 indicate good financial health. FICO scores below 619 make you a bad credit risk. Other types of credit scores (VantageScore, NextGen Score, Empirica, Beacon) may evaluate your creditworthiness differently than FICO scores. For example, a higher score may represent more risk.
Having a good credit score will make your financial life easier. It means that you are more likely to be approved for credit and pay a lower interest rate. Bad credit gives you a hard time to find a profitable offer. The lack of financial responsibility is always associated with a high APR on credit cards and loans. For example, an average interest rate on bad credit cards ranges between 15% - 25%, compared with 8% - 14% APR on plastics for a good credit score.
People with a good credit rating can qualify for the best mortgage deals. Vice versa, customers with a bad credit score will have to choose from a restricted range of offers. Plus, they will be charged a high interest rate and increased mortgage repayments.
Businesses and people that do not directly lend you money (insurance companies, employers, letting agencies, utilities companies and anyone else who “lends” you something valuable) would also like to know how financially responsible you are. Do you want to rent an apartment? Landlords always perform a credit check on those seeking to rent an apartment. Without a high credit score, your application may be turned down.
Your credit score will determine how big deposit you need to make for telephone, electricity or natural gas service. It means that you have to find hundreds of dollars just because you can’t handle your credit accounts properly!
Credit score is used to determine rates for all types of insurance, including auto insurance and mortgage insurance. Most insurance providers use credit-based scoring systems to decide how much to charge. You can lower your premium payments by improving your money management skills.
Do you know that potential employers will also check your credit score? You can disagree that a low credit rating has something to do with your job. However, if you have numerous late payments and loan defaults, it will indicate that you are absent-minded and careless. Everybody can have a couple of late payments, but dozens of them? It is a sign that you can’t control your expenses and even your life.
A potential employer can also decide that if you don't take any efforts to make payments on time, you can’t recognize and solve problems. This quality will not describe you as a good employee. With unemployment at 10 million (a 25-year high), it makes sense to take care of your credit rating.
FICO score is calculated based on the information in your credit report. There are five factors that are taken into consideration.
1. Your payment history – 35%
This category includes payment history information about you credit accounts. Late payments, bankruptcies, loan defaults and other negative items take points away. Vice versa, a solid record of regular timely payments will help you raise your credit rating.
2. How much you owe – 30%
FICO scores consider your total amount of debt on all accounts, the number of accounts with balances, and how much of your available credit you are using. The more you owe compared to your available spending limit, the lower your FICO score will be. It is a well-known fact that the majority of Americans who go bankrupt tend to max out their credit cards.
3. Length of your credit history – 15%
A longer credit history will increase your FICO score. So if you want to close your old account, think twice before doing it. Lenders are looking for borrowers with long credit histories.
4. New credit –10%
FICO score considers how many recent new accounts you have established. A lot of new credit lines will mean that you urgently need money. It will lower your rating.
5. Types of Credit: 10%
This category looks at the overall mix of credit you have: credit cards, installment loans such as a mortgage or auto loan, and personal lines of credit. You need to have a healthy mix of all types of credit, but it is not advised to open new accounts just because you want to improve your FICO score.
By law, credit scores may not consider your age, race, color, religion, national origin, sex and marital status, where you live, salary, occupation, any interest rate being charged on a particular credit card or other accounts, any items reported as child or family support obligations or rental agreements.
Keep in mind that your FICO scores from all the three bureaus can differ. Experian, TransUnion and Equifax have nothing to do with each other. The information they receive from various resources can vary, so your credit score will vary as well. Some lenders can make a credit card or auto loan decision based on a single agency's score, while others such as mortgage lenders order all three scores.
Having no FICO score can be no better that having a bad credit rating. Lenders regard people with no credit as high risk customers because they have no financial experience to manage their debt properly. If you want to establish a FICO score, you need to apply for some type of credit. Many people start with student loans or secure credit cards.
If you want to check your credit score, make a request to one of the three major credit bureaus - Equifax, TransUnion, and Experian. They will evaluate your credit report to formulate your FICO score. Typically, you will need to pay a fee for this service. You will also have to prove your identity to make sure that your financial information isn't given to the wrong hands.
Nothing in the financial world remains the same for a long time. Your credit score changes when your information changes at the credit bureau. So you can improve a poor FICO score over time by improving how you handle credit. Responsible money management is the core of your future financial well-being.
The main rule is to pay your bills on time and avoid your previous mistakes. Go back to the reasons of your financial problems and change your spending pattern. If you used to overspend, plan all your expenses in advance. If you did not have enough money to pay your bills after emergency, establish a rainy day fund.
The banks regularly report your payment activity to the major credit bureaus. Having a positive record of timely payments, you will prove that you are a trustworthy and reliable customer. A good FICO score will ensure your successful financial life in future.
News Source: http://www.ecommerce-journal.com/
