UNDERSTANDING CREDIT SCORES
Creditors want to loan you money for a Home, Car, Furniture, Personal Line of Credit etc…
But they also want to minimize their own risk. The easiest way to mitigate risk is by using your credit scores to make lending decisions.
Credit scores are compiled separately by three consumer reporting agencies -- Equifax, Experian, and Trans Union. These credit reporting bureaus calculate scores differently, and base their scores on information that may differ from other bureaus.
You may have also heard of the term “FICO”. FICO is a software company based in San Jose, California and founded by Bill Fair and Earl Isaac in 1956. Its FICO Score, a measure of consumer credit risk, has become a fixture of consumer lending in the United States.
Scores are based on credit reports and range from 300 to 850. Lenders use the scores to gauge a potential borrower's creditworthiness.
Originally called Fair, Isaac and Company, this name was changed to Fair Isaac Corporation in 2003. The company rebranded again in 2009, and is now called FICO
Your credit score is a number that reflects the information in your credit report, whether you pay your bills on time, how much you owe creditors, payoffs, and derogatory information such as liens. It also includes inquiries into your accounts from lenders, landlords, and employers.
FICO® Scores are calculated from several different pieces of credit data in your credit report. This data is grouped into five categories as outlined below. The percentages in the chart reflect how important each of the categories is in determining how your FICO Scores are calculated.
Your FICO Scores consider both positive and negative information in your credit report. Late payments will lower your FICO Scores, but establishing or re-establishing a good track record of making payments on time will raise your score.
How a FICO Score breaks down
These percentages are based on the importance of the five categories for the general population. For particular groups—for example, people who have not been using credit long—the relative importance of these categories may be different.
When you apply for a loan, your application includes giving your lender permission to "pull your credit" and base the decision to lend to you and the rate of interest on the information contained in your credit scores. The higher the score, the better terms you'll receive from the lender.
Once your credit scores are reviewed by a creditor, you'll receive a computer-generated report of the findings in the mail, but it won't have a copy of your entire credit report. It may include key factors that adversely affected your scores. Some examples might include:
- Too many inquiries in the last 12 months
- Time since most recent account opening is too short
- Proportion of loan balances to loan amounts is too high
- Too many accounts with balances
- Amount owed on revolving accounts is too high
What if you're declined for the loan or your lender wants to charge higher interest than you were expecting? Is there anything you can do?
Yes, talk to your lender and ask for help repairing or correcting your scores. For example, you may have innocently done something that resulted in a negative score, such as closing a line of credit. Or, you may not have realized that a late payment would bring your score down as much as it has. The lender will tell you exactly what you need to do.
Under federal law, you have the right to obtain a free copy of your credit report from each of the national consumer credit reporting agencies once a year. There are several sites where you can go to get your free reports including AnnualCreditReport.com or FreeCreditReport.com.
If you find an error such as derogatory data that doesn't belong to you, or an account that shows the wrong balance, simply show the lender your cancelled check, release of lien or other proof that the credit report is wrong.
You'll also have to correct the information yourself separately with each agency, and it may take a few weeks for the agencies to record the updated information.
In the meantime, work with your lender and do what he/she tells you to do to get the best rate, including paying more than the minimums, paying on time, and making sure that your debt to income is well within your ability to repay all your loans.