What does my credit score say about me?Your credit score is a three digit number that helps to determine the amount of credit (in dollars) you can borrow and the interest (as a percentage) you will owe. In general, the higher your score is, the more money you can borrow and the less you will pay for the loan. The more credit you can responsibly manage and pay back on time, the more creditworthy you are on paper to prospective lenders.
As a side note, interest is the cost of borrowing. If you borrow $5000 from your bank, they expect you to pay back the $5000, plus interest. Interest is the dollar amount you pay for having the luxury to access cash that is not yours; it's the cost of borrowing! Before the 1980s, American banks used to charge everyone the same flat interest of about 20%. After credit scores became readily available to individuals in the late '80s, banks began offering credit with a variety of interest rates, thus tying the cost of borrowing (interest rate) to a person's degree of credit risk. Credit risk is the polar opposite of credit worth.
How is my credit score determined?
Here's the breakdown on your credit score*:
35% is determined by your payment history; that is, do you regularly pay your debts on time? Note that unpaid library fines, medical bills and parking tickets are included in your payment history.30% is based on the amounts you owe each creditor and how that compares with the total credit available to you. If you are maxing out your credit lines, your score will suffer.15% is based on the length of your credit history. The goal here is to have a few accounts (you only need 1 or 2 to establish healthy credit habits) and old accounts, which show that you are a good steward of credit over long periods of time.10% depends on how many accounts you have opened "recently", or how many "recent" inquiries exist on your report; Recent is relative, but know that your score can drop if it looks as if you're seeking several new sources of credit - a sign you may be in financial trouble, and therefore not very creditworthy.The last 10% is determined by the types of credit you have chosen to use. Installment debt is paid in a fixed amount each month, like a mortgage. Revolving debt doesn't have a fixed payment (like with credit cards) so the amount you owe depends on how large the outstanding debt balance is and your prevailing interest rate.
What is a FICO score?
Now when people say "credit score" they usually mean the FICO score. FICO stands for the Fair Issac Corporation, the good folks who invented credit risk scoring. Keep in mind that FICO isn't the only credit score out there (one estimate says that there are over 1,000!) but it is the primary score used by lenders. FICO takes into account the data collected by 2 of the 3 largest credit-reporting agencies, and gives credit scores for Equifax and Transunion*. The FICO score can range from 300 to 850.
Do I need to pay for a credit report?
No! You can get a FREE copy of your credit report from each of the three major credit agencies once a year. How? Visit AnnualCreditReport.com, the only authorized online site under Federal law. Review it carefully and address any errors in a letter sent to the appropriate agency, with any supporting documentation.
How do I get my credit score?
Now this tidbit you are charged for. As stated above, FICO is the most widely used score, and this can be obtained from myFICO.com. Here, you can also get a score from Equifax or Transunion. Remember, some scores are proprietary by the company you choose; as fotenoted below, Experian, while a major credit bureau, no longer partner with FICO to provide credit scores, and instead offers its own model.
What do I do after I get my credit report and score?
Whether or not you need to monitor your credit is debatable. If you are trying to establish healthy credit habits it is in your favor to check your credit yearly or even quarterly to get used to searching for errors and evaluating the outcome of your credit decisions. Or, if you plan on using credit for a major purchase in the next 6-12 months, it would benefit you to check your credit and address any errors beforehand. Not only will you be aware of how creditworthy you are, but you also take the steps to change your economic behavior to become more wealthy and wise about your financial future.
Part III of the Credit Education Series coming soon!!
* This breakdown obtained from the New York Times Online article "Credit Scores: What You Need to Know", 01.06.2009.
* Experian no longer has a partnership with FICO to provide credit scores as of 02.2009
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