Understanding your credit score

Understanding your credit score

Let’s face it, your credit score is often a primary determinant to your ability to purchase a home. So, what is it and how does it work? This information, much of which is provided by Watson Mortgage, should help to clarify these questions.


What is a credit score?

Your credit score is a number based on the information in your credit file that measures the likelihood that you will pay back a loan.The credit score that lenders use is called the FICO score. This helps lenders determine the amount of risk that you present and helps them to determine the amount and cost of money they will lend you. FICO refers to “Fair Isaac Corporation” and this score is provided to lenders by each of the three major credit agencies (Equifax, TransUnion, and Experian). The higher the FICO score, the more likely it will be that lenders of any sort will be willing to take a riskon you. Each of the three credit agencies calculates a FICO score that may varyfrom another, mortgage lenders; however, usually pull a “Tri-Merge” report that incorporates all three scores into one number.


How is your score determined?

The FICO score is determined by a mathematical equation that evaluates many types of information from the consumer credit report for each of the three major agencies. This information considers: types of credit used(10%), amount of newly obtained credit (10%), length of history (15%), amounts owed (30%), and your payment history (35%). Then, this number is compared top patterns in hundreds of thousands of past credit reports. In order for a FICO score to be calculated, the consumer must have adequate credit history (the largest component) and information to be able to determine a base score. Usually, you will need at least one account that has been open for at least six months and at least one that has been reported to the credit agencies within the past six months.


What is included in a credit report?

Identifying information such as your name, social security number, date of birth, employment information, etc. ensure that they are dealing with the right person. Current loans, including data on your payment history and current account information give the potential lender an idea of how well you treat other loans. Finally, a credit report notes any items that may be found in public records and collections items, such as bankruptcies,foreclosures, wage attachments, judgments, foreclosures, etc. Salary, age,race, color, national origin, sex and marital status, residence location, and other information that may not be predictive of future credit performance is NOT part of a consumer’s credit report.


Can my score change?

Yes, your score is dynamic and changes as your credithistory changes. Making payments late or not making payments at all, can have anegative impact on your credit report, while consistently making payments ontime and not using a large portion of available credit can improve it. A poorcredit score can cost you more money, IF the lender will even take a risk onyou. Avoid making repeated “hits” to your credit score by making requests toborrow money as each time this is done your score could potentially decrease,although it may rebound afterwards if the “hit” to the score did not result inthe applicant actually receiving a line of credit.


Can there be errors on my credit report?

Yes, errors on your credit report on common as consumerssometimes apply for loans in various names. Clerical issues can also create imperfectionson your report; hence, if you see an issue, do not just ignore it as it maytake a long period of time before it “goes away”. The federal Fair CreditReport Act (FCRA) requires the credit agencies to maintain accurate records andcorrect errors. If you find an error on your report, simply contact the agencyor agencies with the error(s) and take the appropriate steps to get the errorcorrected. Because of the possibilities of errors, the FCRA allows you toobtain a free credit report from each of the three major agencies once every 12months.


What is a “good” FICO score?

A “good” score can be very difficult to define as what isgood for one situation may not be good for another. In general, scores above620 are considered adequate for borrowing purposes; however, the higher yourscore, the lower the expense of the desired monies. If your score is below 550,it may take up to two years to improve your score dramatically, although somecompanies can improve your score more quickly, but beware of scams makingpromises that are unreasonable. Speak with your lender about what the financialimplications are of an improved credit score as sometimes a very smallimprovement in your score can have a dramatic impact on your monthly payment orloan options. Companies such as Credit Karma, provide a score that is typicallybased on two of the three scores, which could potentially appear better or worse;hence, companies like this can be used as a guide, but I do not advise relyingon their scores completely.


How can I improve my credit score?

Many factors have an impact on your score; however, over thelong-term, consistency is the key to a good score. Paying your bills on time isvitally important as your score can decease dramatically with late ornon-payment. Avoiding opening too many credit inquiries too quickly can be agreat help to your score. Keeping your overall debt in relation to amount youhave available to borrow is a large part of your score as lenders want to knowthat you are not “maxed out”. Having unneeded credit accounts can lower yourscore if they are not used and accounts that are closed out may have a negativeimpact on your overall score. It may appear that having credit cards is goodfor your credit, and that is true; however, having significant amounts of debt oncredit cards may also mean that you are paying a bundle of interest, which isnever a good thing.


What if I don’t have a credit score?

Plain and simple: get one. Begin by applying for a creditcard with any of the major card companies, or by checking with a local creditunion, that often have “starter” cards that can help individuals get startedwith a credit score. Local banks or credit unions sometimes offer “secured”cards, which require you to put up the funds to back the card for a period oftime. Having no score can be more detrimental to your ability to borrow moneythat having a bad score, so it is important to have some credit. Having a couple cards with minimal balances that arepaid off monthly to avoid interest expenses can be a wise choice and save you abunch of dough when you do need to borrow monies.


What is my credit score?

To my knowledge, there is only one site that will provide afree credit report for FREE, and that is www.annualcreditreport.com. There aremany other sites that will claim to be free, but they are NOT free, so pleasebeware. You are also entitled to a free credit report under the following circumstances:you applied for a loan and were turned down, you are unemployed and planning toapply for jobs in the next 60 days, you receive public assistance, you believeyour credit file contains mistakes due to fraud, or you currently reside in astate that offers a free annual report from each of the credit reporting agencies(no, Florida is not one of them).


Do I really need a good credit score?

No, you do not need a good credit score, or any credit forthat matter, IF you never have a need to borrow money. If you have the fortunatecircumstances that allow you to spend your life working from a cash onlyperspective, then you have no need for credit. However, the remaining 97% of usdo need to utilize credit, if only for major purchases such as the purchase ofa home. Borrowing money is very expensive and can have a significant impact onyour ability to be financially healthy. Financial health is another topiccompletely, but I believe that significant debt is detrimental to goodfinancial health. A good credit score can help lower the burden of interestexpense and help you get to debt-free living more quickly.

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