Monday, August 30, 2010

Monday Money Sense- Credit Scores

This week we are talking about the always confusing credit score. Confusing because a lot of people do not understand it, but I'm here to help with that.

What is a credit score?
 A credit score is a number used to determine your credit worthiness. It ranges from 300-850, with 300 being bad and 850 is good. Most Americans are around around the 720's. Each credit bureau has a credit score, so each person has three credit scores.

How is a credit score determined?
This is a fun one! The actual formula isn't readily known, but there is some general information on how the score is determined.

35%- Payment History- Paying Bills on time raises your score, late payments lower your score.
30%- Credit Utilization- What is your debt to credit ratio? The closer you are to your credit limit the lower your score, the farther from the credit limit the higher the score.
15%- Length of Credit History- The longer your accounts are open, the higher score. The shorter they've been open, the lower the score.
10%- Types of Credit Used- Revolving, installment, mortgage, etc. You benefit from showing responsible usage in multiple areas.
10%- Credit Inquiries- How many times has your credit been pulled to offer you credit? Too many and your score goes down, so don't go signing up for every credit offer you get.

How do I improve my credit score?
It takes time. If it is incorrect information, work to get it removed. If it is correct however, it will take a length of time for your score to go back up. For example, late payments become less of a negative the farther in the past they are. If it's your debt to credit ratio, pay down your debt! People with excellent credit scores, often have been using their credit correctly for many years.

Why should I care what my credit score is?
Although it's possible to do things with bad or no credit, life is easier with good credit. Good credit means good interest rates, good insurance rates, and sometimes if you can have a job. Unfortunately, many companies use your credit score as a means to determine the kind of person you are. Equally unfortunate is that a credit score actually is not a great way to determine who you are. Confusing? The reality is sometimes people with good credit can end up in bankruptcy/foreclosure and people with bad credit can pay every bill on time and just had a series of bad luck several years ago. Credit scores are not an exact science.

How do I get my credit score, and when should I get it?
Most of the credit bureaus will tell you how to get your score when you get your report. It typically costs around $10. You'll also get it if your score has been pulled for a loan. If you have never seen your credit score, it may be wise to get it now, so you know where you stand. If your planning on obtaining a mortgage, car loan, or other types of loans, you probably would like to know in advance. The reason for this is so you can research what interest rate you should be entitled to. It will also keep you from having any surprises, like being denied because of your credit score.

I finally just paid off one of my cards, should I close it?
I put this one on here because a lot of people ask this question. The answer is generally no. The reason is simple it affects your score in two ways. The first is you credit length because it changes the average length of time your accounts have been open. This is usually the only thing people think about when making the decision, and they usually rationalize that it is only 15%.  But closing an account also affects your debt to credit ratio. Closing a card closes the credit limit on the card, so then any debt you have is now closer to your credit limit. This accounts for 30% of your credit! When you add it to the other you get 45%, that's practically half of what your score is made of.
Now here's the thing usually the intention behind this is to keep yourself from getting into it again, and so it's easy to see why someone would want to do that. By keeping the card open with a zero balance, your score will receive a boost because you have now bettered your debt to credit ratio. Don't close the card if it can at all be avoided.

I hope credit scores became a little less mysterious for you. Join me next week for more money sense!
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