By Jane Young, CFP, EA
Credit scores are used by lenders to determine if they will give you a mortgage, a personal loan or credit card and what interest rate will be charged. Your credit score is a quick snapshot of the risk lenders take when lending you money. Your credit score may also be a factor in determining the premium you pay on home and auto insurance.
The most well know credit scoring system called the FICO® score was developed by the Fair Isaac Corporation. This is used by the three major credit bureaus Experian, Equifax, and TransUnion. FICO® scores range from 300 to 850. According to myFICO.com, a score above 800 is considered exceptional, 740-799 very good, 670 -739 good, 580 -669 fair and below 579 poor.
Your credit score has a significant impact on the interest rates you pay. A study conducted by Lending Tree found that borrowers with a “fair” score pay over twice as much interest on personal, auto and student loans and 97% more on credit cards than those with a “very good” score. Based on the calculator at www.myFICO.com, a borrower with a $300,000, 30-year mortgage and a score between 700 and 759 will pay close to 1.4% less in interest than a borrower with a score of 620-639. This results in a savings of $227 per month and $81,123 over the life of the mortgage.
To improve your credit score, annually check your credit reports with the three major credit bureaus and immediately report any errors. You can claim a free report from each bureau once every 12 months by going to www.annualcreditreport.com.
Paying your bills on time is the most significant factor in determining your credit score with a weight of 35%. Even occasional late payments can have a negative impact on your score. Consider establishing systematic payments to autopay a set amount every month.
The second most significant factor is your credit utilization rate with a weight of 30%. Avoid charging credit cards up to your limit. An optimal utilization rate is between 10% and 30%. Credit bureaus like to see credit card balances paid in full every month. The balance on your card is reported monthly, shortly after the statement closing date. You can help your credit score by paying your credit cards early or twice a month.
The length of your credit history accounts for 15% of your credit score. This is determined by the age of your oldest account and the average age of all your accounts. Keep your older credit cards open and use them periodically, if you are not paying a large fee.
New credit inquires account for 10% of your score. Be cautious about applying for new credit unless you really need it. You lose points just by applying for a new credit card or line of credit. Finally, having a mix of different types of credit, such as a mortgage and credit cards, influences 10% of your score.