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Understanding Your Credit (FICO) Score

A big part of being a “responsible adult” is managing your credit score.  Also known as your “FICO” score, this number represents your credit worthiness to potential lenders, insurance companies, and even some employers.

While I could easily write volumes detailing every aspect of your credit scores, how they work, and what they are used for, for today we’ll try to just cover the basics that you need to know most.

This article covers the various components that make up your credit score and offers tips on how best to manage these factors to maximize your credit score.

(If you’re interested in more information, you can read more about your FICO scores here).

The Basics

While most people talk about their credit “score”, in reality, you have three credit scores – one for each of the three main US credit reporting agencies (i.e. Equifax, Experian, and TransUnion).  Below are some basic facts:

  • Your score can vary between each of three agencies because not all companies and creditors report to all three of the agencies
  • Overall, your scores should be within a reasonable range between the three agencies
  • Your bank/lender may use all three or only just one of the agencies to determine your credit worthiness
  • Your credit scores can range from 300 (super bad) to 850 (flawless)
  • Even for those with perfect credit histories, it is difficult (if not impossible) to max out your FICO score at 850
  • Those who have what we would consider “awful” credit rarely go all the way down to 300
  • Banks and other lenders may use other “scores” that they calculate themselves, using information from your credit app or prior history with them

First Things First – Get Your Free Credit Reports

Before you can evaluate and improve your credit scores, you need to know what they are.  Did you know that you are allowed, by law, to receive one copy of your credit score every 12 months from each of the credit reporting agencies?

There is only one website that is authorized to provide you with your free annual credit reports, and that is annualcreditreport.com.  Do NOT contact the three credit reporting agencies individually.  They will try to sell you your credit score (which is fine if you’ve already gotten your free one, of course).

If you decide to purchase credit reports, I recommend the “Standard” reports at myFICO.com.

If you see any errors on your credit reports, don’t panic.  Those can be fixed, primarily by contacting the credit agencies and providing proof that the information is incorrect.  Removing erroneous information is not addressed in this article.

You should review each of your credit reports once every twelve months, at a minimum.

Credit “Monitoring”

While we’re on the topic of getting credit reports, I must say: please do NOT subscribe to those monthly “Credit Monitoring” services that charge you a monthly fee to warn you about changes in your credit report.  I believe that they are unnecessary and a total rip-off.

In my opinion, the only use for daily credit monitoring is if you are applying for a mortgage and need to know if anything changes on your reports while you’re going through the process.  You should not be opening new lines of credit while you’re applying for a mortgage anyway!  In that event, you may want to use the service and then cancel it immediately after getting your mortgage.  Be prepared for lots of squealing and warnings about protecting you from fraud on the other end of the line when you call to cancel.

These services are big money makers for the various agencies and companies that sell these “services”.   You’d be better served by contacting each of the agencies and putting “fraud alerts” on your accounts, which will prevent any new credit accounts from being opened.  (Be advised that when you place a fraud alert on your account and YOU try to open new credit lines, you will be declined and have to call to authorize the new credit line).

A Warning About “Imposter” Websites

From ftc.gov:

Other websites that claim to offer “free credit reports,” “free credit scores,” or “free credit monitoring” are not part of the legally mandated free annual credit report program. In some cases, the “free” product comes with strings attached. For example, some sites sign you up for a supposedly “free” service that converts to one you have to pay for after a trial period. If you don’t cancel during the trial period, you may be unwittingly agreeing to let the company start charging fees to your credit card.

Some “imposter” sites use terms like “free report” in their names; others have URLs that purposely misspell annualcreditreport.com in the hope that you will mistype the name of the official site. Some of these “imposter” sites direct you to other sites that try to sell you something or collect your personal information.

Annualcreditreport.com and the nationwide consumer reporting companies will not send you an email asking for your personal information. If you get an email, see a pop-up ad, or get a phone call from someone claiming to be from annualcreditreport.com or any of the three nationwide consumer reporting companies, do not reply or click on any link in the message. It’s probably a scam. Forward any such email to the FTC at spam@uce.gov.

How is My Credit Score Calculated?

There are five weighted components to your FICO score:

  1. Payment history (35 percent)
  2. Amounts owed as a percentage of total available credit (30 percent)
  3. Length of credit history (15 percent)
  4. New credit lines (10 percent)
  5. Types of credit used (10 percent)

There is tons of information available online regarding how best to maximize your credit score and various theories as to the best way to improve each of the factors above.

For the purposes of this article, I’ll just review the information that I believe you need to know most.

1. Payment History (35 percent)

As you can see, this is the biggest factor.  To maximize this portion of your score, you should stay current on all of your payments, especially loan and minimum credit card payments.  Keep in mind that other companies, such as your utility companies, can report delinquencies as well.  It is always advisable to call your creditor(s) in the event you will not be able to make your payment so that you can try to work out some sort of arrangement and avoid being reported “delinquent”.

There are usually “grace” periods (typically 20 to 30 days but some as low as 0 to 5) before you will be considered delinquent and reported as such to the credit agencies.  These grace periods vary among companies.

Delinquencies stay on your records for several years.  Avoid late payments at all costs.

2. Amounts Owed as a Percentage of Total Available Credit (30 percent)

This simply is the amount of credit you’re using compared to your total credit limit.  This is most relevant to your revolving lines of credit (i.e. credit cards).

To maximize your scores, you should ideally use little to none of your available credit.  For most families that is not practical.  If you must carry a balance, keep it to less than 50 percent of your total available credit.

While this factor primarily relates to your total available credit over all, it would generally be advisable to use several cards, each being under 50 percent utilized, than to just use one card that is 85 percent utilized and have the others with a zero balance.

As a general rule, the lower the utilization, the better.  50 percent and above is getting into “bad” territory.

3. Length of Credit History (15 percent)

If you’re young, there isn’t much that you can do about this one.  If you don’t have an established credit history, the best advice to improve this factor would be to keep your oldest credit lines open, even if you never plan to use them again.

You can always close them later when you have had better credit lines established for several years.

4. New Credit (10 percent)

This factor takes into consideration the number of new credit lines you’ve opened recently.  It also considers recent credit inquiries (i.e. “hard” pulls – typically not inquiries made by you, your insurance company, or your employer).

To best improve this factor, try not to apply for credit cards or store credit unless you really need it and/or intend to keep it open and use it.

5. Types of Credit Used (10 percent)

Lastly, this factor takes into account the mix of credit lines you have used or are currently using.  Typically, lenders like to see that you are responsible with your credit usage, and that you have a history with a variety of lenders, such as banks and other creditors.

To improve this score, consider using a range of credit products, such as a mortgage, auto loan, student loan, and a small number of revolving lines of credit.

However, do not open lines that you don’t need just to improve this factor, as it makes up such a small part of your total credit score.

In Conclusion

I hope you’ve found this information useful.  There’s a ton of information available to you on the Internet, and a million opinions when it comes to how best to manage or improve your credit.

The best advice is to know what’s on your credit reports, correct any erroneous information, and be aware of how your scores are calculated.  Beyond that, just do your best to be responsible with your credit so that it will be there when you need it and that you won’t be charged an arm and a leg in interest!

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