An easy primer on understanding and raising your credit scores
To help you get up to speed fast, here's a quick primer on credit scores, based on eight common credit questions:
1. What exactly Is a FICO credit score?FICO scores get their name from Fair Isaac Corporation, the Minneapolis-based company that creates FICO scores. All FICO scores range from a low of 300 points to a high of 850 points. While there are various types of credit scores in the marketplace, FICO scores are the most popular, with more than 90% of top banks in America using FICO credit scores when checking a consumer's credit history.
Your credit score serves two purposes. First, it summarizes how well you've handled past credit obligations by giving you a three-digit credit score, which is the equivalent of a financial grade. Additionally, your credit score tells prospective lenders how likely you are to repay (or default on) credit or a loan in the future. The higher your credit score, the more statistically likely you are to repay your bills on time. The lower your score, the more likely you are to pay late or default on a debt.
2. What's considered a "good" credit score these days? Before the credit crunch, a credit score of 620 was high enough to get you approved for mortgages and most loans. Nowadays, many banks consider a FICO score of 700 and above to be a "good" credit score.
In my forthcoming book, Perfect Credit: 7 Steps to a Great Credit Rating, I offer the following guidelines:
759 - 700 Good
699 - 650 Average
649 – 620 So-So
619 and below Poor
3. What does it mean if I've been told I have no credit score? What can I do about It? If you've heard that you have a "thin" credit file, "no credit file" or "no credit score," it's likely due to one of three causes:
- You've never had any credit.This would be the case if you've never had a traditional credit account, such as a car loan or credit card. Or perhaps you opened one many years ago, but you've long since stopped using it and your entire credit history has been dormant for many years.
- You just recently established credit.Another possibility: You may have actually had credit extended to you, but it was established so recently that the account isn't yet being reported by your creditor or tracked by credit bureaus. According to the three major credit bureaus (TransUnion, Equifax and Experian), it can sometimes take as long as four to six months for newly opened accounts to be reported to the bureaus. In the meantime, try not to worry too much about it; those accounts should be reported soon.
- Someone thinks you're dead.No, seriously. The Social Security Administration supplies something called a "Master Death Index" to credit bureaus, other businesses and government agencies. If your Social Security number somehow winds up on that list, you're presumed to be deceased. Obviously, that makes it pretty tough to get a Visa card.
4. Why are my credit scores all different? You can have multiple credit scores for several reasons. For one thing, there may be differing information in each of the main credit files maintained on you by Equifax, Experian and TransUnion.
Another possibility: You may be looking at one type of credit score, like a FICO score, and someone else, such as an mortgage lender, is using a completely different credit score, or even a score based on a "tri-merged" credit report – one that looks at all three credit files together.
Other well-known credit scores, besides the FICO score, include the Experian PLUS score and the VantageScore. Experian's PLUS score is very similar to the FICO score but has a different scale, ranging from 330 to 830 points. The VantageScore, which was jointly developed by Experian, Equifax and TransUnion, ranges from 501 to 990 points.
According to Barrett Burns, CEO of Vantage Solutions, the VantageScore differs from the FICO score in several key ways. For starters, the VantageScore captures a broader array of payment information about consumers, including how consistently consumers pay their utility bills and other non-traditional forms of credit. It's also "more predictive," Burns told me, because it relies on more recent consumer data and insights gleaned during the credit crunch, as opposed to FICO's classic score model, which is based on older consumer data.
Burns said consumers can purchase a copy of their VantageScores from Experian and TransUnion, but not from Equifax, due to Equifax's longstanding exclusive contract with Fair Isaac, creator of the FICO score.
When the VantageScore debuted a few years ago, most experts panned this type of score since lenders weren't using them at all. Amid the credit crunch, however, VantageScores have grabbed a 6% market share. Some people attribute their growing popularity to criticisms of the FICO score, and whether it failed to accurately predict which consumers would default on their home loans during the mortgage meltdown. (Fair Isaac officials reject those criticisms).
In any event, even though the VantageScore's 6% market share is small compared to the widespread use of FICO scores, it illustrates that banks are increasingly looking at alternative credit scoring models – so perhaps you should, too.
5. How are my credit scores calculated? Your credit scores are derived from the information contained in your Equifax, Experian and TransUnion reports. To calculate your FICO credit scores, officials from Fair Isaac look at the following categories from your credit bureau reports and weight them (assign them percentages) like this:
Payment History - 35%
Amount of Debt Owed - 30%
Length of Credit History - 15%
Mix of Credit - 10%
Inquiries or New Credit - 10%
As a side - but critical -- note: In recent years, consumers could get three FICO scores, based on each of their credit reports from TransUnion, Equifax and Experian. As of February 2009, however, Fair Isaac stopped selling Experian-based FICO scores because of an ongoing lawsuit between the two companies. So currently, you can only purchase a copy of two of your FICO scores, one based on your TransUnion report, and the other based on your Equifax credit report.
Here's the skinny on each category listed above:
Payment history: Having no late payments will net you the highest possible ranking in this category. But even if you slipped up in the past, the hit to your credit scores will depend on how long ago the late payment occurred and the severity of the missed payment. A delinquent payment that happened three years ago will have far less impact than one that happened three months ago. Similarly, a 30-day late payment won't be as damaging as a payment missed for 60 days, which in turn won't hurt you as much as a payment that's 90 days late.
Amount of debt owed: When it comes to credit scoring, all debt is not created equally. The credit-scoring system most closely scrutinizes credit card debt, also known as "revolving" credit. So don't worry about your mortgage debt, student loans or that car loan on your credit files – as long as you pay those bills on time. Focus instead on reducing or eliminating credit card debt.
Your goal is to have a low "credit utilization" rate – 25% or lower. That refers to the percent of credit card debt you've charged, compared with the amount of credit you have available. For example. let's say you have two credit cards, each with a $5,000 credit limit, or $10,000 total. If you've charged $1,000 on each card, or $2,000 collectively, your credit utilization rate is 20%.
Length of credit history: Simply put, the longer your credit history, the better your credit rating. Therefore, even if you pay off some of your credit cards, don't close those accounts, especially cards you've had for many years. Closing credit cards can backfire on you, by decreasing the length of your credit history and raising your credit utilization ratio.
Mix of credit: The credit-scoring world rewards you for showing that you can responsibly juggle multiple forms of credit. Consequently, you get brownie points for having a credit file that includes various types of credit, such as a mortgage loan, an installment loan (like a student loan or auto loan), and credit cards. Again, your main objective is to pay all these obligations in a timely fashion. If you do so, you'll score major points in this category.
Inquiries or new credit: An inquiry is placed on your credit report any time you apply for a loan or credit – regardless of whether or not you get approved or accept that loan. Inquiries stay on your credit reports for two years. For the purpose of calculating your FICO scores, inquiries count against you for one year. The American Bankers Association (ABA) says a single inquiry can lower your credit score by up to 35 points. So skip those department store credit card offers; they just generate inquiries.
6. Does my age, race, gender, marital status or Income affect my credit rating? No. None of those factors are taken into consideration when your credit scores are determined. In fact, under federal law it is illegal for credit-scoring to take into account race, age, nationality, religion, sex, or marital status.
7. If I pull my credit reports or credit scores, will that hurt my credit? Not at all. It's a common myth that pulling your own credit report or credit score will somehow lower your credit rating. But that's just a terrible misconception. In reality, you can view your credit reports and pull your credit scores as often as you'd like – even monthly, weekly or daily if you so choose – without any impact on your credit scores.
Examining your own credit files is considered, in industry lingo, to be a "soft" pull. These consumer inquiries don't affect your credit scores. By contrast, when you apply for credit or a loan, that's deemed to be a "hard" pull, and "hard" inquiries are taken into account when your credit scores are computed. Those hard pulls can lower your credit scores -- by as much as 35 points, as we pointed out earlier -- but exactly how much depends on the number of total inquiries in your credit report within the past year, as well as all the other factors contributing to your overall score.
Unlike credit reports, which you can get at no charge at www.annualcreditreport.com, most credit scores aren't free. You can visit Fair Isaac's consumer website to get your FICO scores. They cost $15.95 each. An Experian PLUS score will cost you $14.50. VantageScores can be obtained directly from the credit bureaus. They cost $7.95 at Experian, $7.95 (or $9.95 online) at TransUnion.
One company that does offer completely free credit scores – without you having to sign up for credit monitoring or use a credit card at all – is CreditKarma.com.
"Ten years ago, consumers didn't even know what a credit score was for the most part," CreditKarma.com CEO Kenneth Lin told me when I interviewed him recently for Perfect Credit. "Today most people know what scores are, but I think there's still a lot of ambiguity and confusion about how they work."
That's why CreditKarma.com provides the public with credit-education articles, a "Credit Simulator" and other online tools, along with a nifty Q&A section that lets users submit questions about their credit problems or issues they don't understand. Launched in early 2008, CreditKarma.com now has well over 1 million registered users and has given away several million free credit scores.
"We have a very strong focus on credit education and transparency, which I think is lacking in the industry," said Lin.
8. How can I improve my credit scores? The single best way to boost your credit scores is to consistently pay all your bills on time. You can also improve your credit rating by:
- reducing credit card debt,
- disputing mistakes in your credit reports,
- adding positive information that may be missing to your credit files (such as loans that you paid off),
- actively monitoring your credit reports, and
- limiting inquiries by only applying for credit when necessary.
Mastering your credit isn't rocket science. Just by remembering these basics, and putting the above-mentioned tips into action, you can dramatically raise your credit profile, and sidestep the numerous credit pitfalls that ensnare so many others who lack basic credit education.