Your Credit Score
By Jeff Greenspan, Managing Director, Financial Modeling Services
The world is complex, so we humans are always looking for ways to simplify it. Your credit score is one way the business world tries to simplify you! It is the fastest way for any business to quantify the risk associated with loaning you money. If your credit score is low, the risk that you won’t pay back a loan is higher, so the lender compensates for that risk by charging you more than s/he would charge someone with a higher credit score. This probably isn’t fair, in that it leads to discrimination against some segments of society, but you can level the playing field if you understand and manage your credit score. So, let’s GET STARTED.
There are three companies that track your consumer spending (and paying!) activities: they are Equifax, Experian and TransUnion. If you have ever opened a bank account, or a store credit account, or most utility accounts, or many monthly payment service accounts like Netfix or Spotify, or taken a loan to buy a car, or set up a payment plan for medical bills, these companies know about you. They track personal information about you, they track the total amount of credit you have available, and they track and report your ability to make the payments you have promised to make. You can look at sample credit reports here: the TransUnion link includes a video on how to interpret their report.
Your credit history is maintained for years, but the last 24 months are the most important.
You should review your own credit report at least once per year. It is a good idea to obtain all three of the free reports each year: rotate among the three providers and put it on your calendar so you don’t forget! Read the report carefully to verify that the information is correct and to see if there has been identity theft. Request your free report
- Online: www.AnnualCreditReport.com
- By phone: 877-322-8228
- By mail: Get the form at https://www.consumer.ftc.gov/articles/pdf-0093-annual-report-request-form.pdf. Mail it to
- Annual Credit Report Request Service
- P.O. Box 105281
- Atlanta, GA 3034 8-5281
Your credit history is condensed into a set of almost 50 different credit scores, each of which is used for different purposes. One might be used to get a $500 store credit card, while another would be used for a home mortgage. The basic FICO® credit score1 is the one most frequently used, especially by credit card companies. This is also the score that you will see if you request a credit score. Basic scores range from 300-850, and the average score is 673.
Why is your credit score important? Landlords, employers, and potential creditors look at them to make judgements about you. A poor credit score could prevent you from leasing the apartment that you want. A good credit score will reduce your cost to borrow money, potentially by a lot! People with scores below 620 are considered a poor credit risk and have trouble getting credit cards and loans. Here are example loan rates from January 2014 for a $300k 30-year fixed mortgage…note the difference between a good score and a poor one is $286 per month!
|FICO Score||APR||Monthly Payment|
How do you find out your credit score? Credit scores are not typically included in your free credit report, but anyone who runs a credit check on you will give you a copy of your report if you ask for it. Their copy will include your credit score. You can also pay for a report that includes your score, but that typically isn’t necessary because many free online tools will tell you your score, including Credit Karma, most credit card portals, and most mortgage company portals.
Though no one knows exactly how credit scores are calculated, we do know the basic ingredients. Remember that the last 24 months of your history are the most important in calculating your score.
To improve your credit score, follow these steps:
- Review your credit report regularly. Correct factual errors.
- Deal with negative items.
- Pay every bill on time.
- Know your ratios.
Mortgage debt ratio = monthly mortgage debt ÷ monthly gross income
Calculated on PITI. Keep <= 0.28
Debt to income ratio = all debt payments ÷ gross income
Keep < 0.36 – many mortgage lenders will not exceed this number
Revolving credit ratio = credit balance ÷ credit limit
< 0.3 is ideal, consider each revolving account AND all accounts together
This tip alone will add 10 points to your score!
- Mortgage debt ratio = monthly mortgage debt ÷ monthly gross income
- 3 revolving accounts (credit cards) is ideal. 6 is too many.
- Pick your cards and stick with them. 5+ years is ideal.
Hint: Don’t close a card just because a better one comes along. Try negotiating with your current company.
- Retail credit accounts (cards) hurt your credit score.
- Keep credit inquiries to a minimum.
- Pay balances in full before closing an account.
Lastly, given the prevalence of identity theft, I recommend everyone keep their credit reports frozen. This prevents anyone else from opening credit in your name. You can find details in this Federal Trade Commission article.
Investopedia: www.investopedia.com is the first place I look for definitions and straight-forward explanations.
Green Path: www.greenpath.com is a national non-profit focused on financial wellness for everyone.
CreditBoards: www.creditboards.com is a highly active message board for advice on different kinds of credit situations.
1 The Fair Isaac Corporation (FICO) creates the algorithm for calculating the most frequently used credit score.