Understanding Your Credit Score

by D. Ray Lewis

When my wife and I were first married, we decided to purchase a television on credit. Feeling all grown up, we went to the store, filled out the paperwork, and then had to wait a few days to see whether or not we were approved.

Today, consumers can go online and get approved for credit within 60 seconds. We can get pre-approved for a car loan without answering any questions about how much money we make. We can apply for the same loan at the same place as our neighbor, and we may get one interest rate while our neighbor gets another.

What has changed through the years? The answer is credit scoring.

The term credit score usually refers to a three-digit FICO score ranging from 300 to 850. The term FICO comes from the company that began the calculation of credit scores, the Fair Isaac Corporation. When you apply for credit, lenders want to know what risk they will take by loaning you money. They depend on your credit score to determine whether or not to give you credit, and how high your interest rate will be. The higher the number, the better you look to them.

If you have an existing credit card, the issuer is likely to look at your credit score to decide whether to increase your credit limit or whether to charge you a higher interest rate.

In general, five factors affect your score:

Payment history (35%). This includes information on how you’ve paid credit card bills, installment loans, mortgage payments, etc. It also includes any adverse public records such as bankruptcy, liens, or collections. Paying all your bills on time is good. Paying them late on a consistent basis is bad.

Amount you owe (30%). The second factor affecting your score is your outstanding debt—how much you owe. This includes the total amount of credit you have available. People with the highest scores use credit sparingly and keep their balances low.

Length of credit history (15%). The longer you’ve had credit, particularly if it’s with the same lenders, the more points you get.
New credit (10%). This provides details on how many accounts you’ve opened recently compared with your total number of accounts. Your score can drop if it appears you are seeking several new sources of credit, a sign of financial trouble.

Types of credit used (10%). The best scores will have a mix of revolving credit (credit cards), and installment credit (mortgages and car loans).

Installment debt demonstrates that you can manage a large loan. How you handle revolving debt tends to carry more weight, because it is seen as a picture of your future behavior. (You can pay off the balance each month or just the minimum; max-out your credit cards or rarely use them.)

In light of our present economy, good credit isn’t just nice to have. It is essential if you want to level the playing field with lenders. At one time in the not-too-distant past, a credit score of 720 was enough to get the best loan terms. Even people with lower scores could get decent deals, and at the peak of the lending boom, it seemed that no score was too low.

Today, lenders typically demand a minimum score of 740 for the best mortgage rates. Lower scores mean higher rates or perhaps no loans at all.

One of the major drawbacks to credit scoring is that it relies on information in your credit report, which may contain errors. That is why it is extremely important to check your credit reports annually, or at least three to six months before making a major purchase. That will give you sufficient time to correct any errors before a lender checks your score.

You cannot get your credit score without paying a fee. However, what is reported on your credit report is what determines your credit score, and you are entitled to see your credit report once a year at no cost from each of the three credit reporting agencies, Equifax, Experian, or TransUnion. To obtain a free credit report, simply go to www.annualcreditreport.com.

If you notice inaccurate information, you can submit a request for removal to one of the three agencies above. Be sure to specify which information is inaccurate and why. Include any documents to support your claim. Ask in writing that the information be corrected or removed from your report.

By law, the bureaus must investigate your complaint and give you a response in writing along with a free copy of your report if the information is changed. Your score should reflect that change shortly afterwards.

Having a good credit score is important when applying for new credit or loans. The best way to maintain good credit is to pay on time, pay more than the minimum, and monitor your credit report at regular intervals for any inaccurate details.

About the Writer: D. Ray Lewis joined the Board of Retirement in 1983. He became director in 2005 after serving for several years as assistant director.