Thursday, 25 May 2017

Buy a car, rent an apartment, or open a credit card, and you're bound to hear it: "We need to check your credit rating."

Your credit rating—or credit score—is important, but why? What makes a good credit score, and how do you go about getting a good score? 

A good credit score is the key to being approved for a credit card, getting a low interest rate on your mortgage or loan, being approved for an apartment rental, and opening an account with a utility company without needing a security deposit.

Insurance companies may use credit scores to help determine whether or not to grant you insurance and what premiums to charge. Even potential employers may look at credit scores as part of their hiring process. The end result? Credit scores may affect your ability to get a lease, car, a new job, insurance, or any type of reputable loan or financial advance. 

Understand the scoring system

Your credit score is called a FICO ® score (this stands for Fair Isaac and Company, which is the organization that created the scoring software), and it's used in more than 90 percent of lending decisions in the U.S., according to myFICO.com

Your credit score can range anywhere from 300 to 850. According to Fair Isaac, 60 percent of Americans have a score below 750. While the actual formula is "secret," the Federal Trade Commission estimates that your total score is roughly based on the following factors: 

  • 35 percent is based on payment history. Do you have a good record of paying bills on time, or are you delinquent in making any payments? 
  • 30 percent is based on any outstanding debt you owe, including mortgage, car loan, credit cards, and current credit lines.
  • 15 percent is based on the length of your credit history. How long have you had current accounts open, and how often do you use them? 
  • 10 percent is based on the types of loans and credit you have, like major credit cards, department store cards, home loans, student loans, and auto loans. 
  • 10 percent is based on "new credit." Have you recently opened (or tried to open) any new credit accounts? Have there been a lot of "hard" inquiries into your credit rating lately? (These are inquiries from potential lenders reviewing your credit score, usually for mortgage, auto loan, or credit card applications. Exceptions apply if you are shopping for best rates among lenders.) 

Factors such as your race, age, income, employment status, ethnicity, sex, national origin, marital status, and religion are NOT considered when calculating your FICO ® score.

Know your score

There are three credit bureaus—Experian, TransUnion, and Equifax—that keep credit information on you and calculate your FICO ® score. The Fair Credit Reporting Act (FCRA) allows you to request one free credit report per year from each of the three companies listed above. You can order your annual free reports by going to www.annualcreditreport.com or calling toll-free 877-322-8228—but the free credit report does not include your credit score. 

The FCRA also gives you the right to see your credit score from these companies for a fee (usually around $8). When you buy your credit score, you often receive information on how to improve your score. 

How credit scores impact everyday life

Credit scores could directly impact the amount of money you shell out every month on things like home mortgages, auto loans, and credit card debt. For example, two potential homebuyers apply for a 30-year fixed $200,000 mortgage. One has an excellent FICO ® of 760 and the other has a respectable score of 650. It would not be uncommon for the borrower with the higher score to receive a mortgage rate approximately 1.5 percent lower than the other potential homebuyer. The lower rate will result in a payment difference of almost $68,000 less over the life of the mortgage. 

The takeaway? A good credit score can lower your monthly payment—which adds up to big savings over the long haul. 

You can recover from credit fumbles

The good news is that even if you've had some credit fumbles, you can improve your FICO ® score by following the steps listed below. But remember, this is a marathon, not a sprint—it generally takes at least six months to see any improvement.

Correct any errors on your credit report. Are there any payments listed as late that you know were paid on time?

Pay your bills on time. If possible, enroll in automatic payments with your credit card and loan providers to have payments automatically debited from your bank account.

Pay down any debt and don't be "maxed out" on your available credit limits. If you are close to your credit limits, it will have a negative impact on your score. The rule of thumb is to limit outstanding balances to 25 percent of the credit limit.

Establish a credit record. If you've never had a credit card or taken out a loan, you may have insufficient credit history. There are several options available to you. Apply for either a secured credit card, a store credit card (a department store credit card is often a good first step—however, you are often restricted on where you can use the store credit card) or a basic credit card. Once approved, make timely payments and maintain a low credit card balance. 

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