Credit Score – Check It, Repair It, FICO and Factors

The “credit score” was first developed for use in the United States although it was not actually used until the 1980s to determine a person’s creditworthiness. Obviously, FICO has evolved to keep up with spending and lending policies but after the most recent change to FICO, the system is without doubt very precise in being able to predict risk level of people. With this, creditors and lenders can make more informed decisions on the people they want to offer credit or lend money to, which is helpful to the creditors but also the economy as a whole.

Today, most people have a decent understanding of what the “credit score” is and most understand how this three-digit number is generated.  However, even the most knowledgeable individuals have questions, especially those pertaining to modifications made to the most popular credit scoring system from Fair Isaac Corporation, or FICO.  Although some of the information can get a little complex, it is important for consumers to have a good idea of how the number is generated, what affects it, how it is scored, and more so they have the opportunity to manage finances in a more controlled and effective manner. Check your score annually, getting a freecreditscore is possible.

Credit Score Factors

If you look at the financial crisis that began in 2007, one of the primary challenges was the huge amount of consumer debt specific to credit cards.  Although mortgage and automobile loans were also serious factors, credit card use had spiraled out of control.  Prior to this event, creditors were offering revolving credit to people that honestly had no business carrying a credit card.  As a result, many credit cards were mismanaged, which led to over spending and slow or no payment schedules.  Soon, creditors were holding the bag for millions of dollars, which snowballed out of control.

Using the FICO credit scoring system, as well as others such as the VantageScore 2.0, creditors can bypass making offers to consumers considered high risk, instead only making credit card offers to consumers they feel confident will handle the account wisely and make payments on time.  While FICO is the most commonly used system, VantageScore 2.0 is another tool that benefits creditors.  This second credit scoring system was actually developed by all three of the credit bureaus and as with FICO, thanks to a new version 2.0 version just released in October of 2010, it provides a means for creditors to obtain an accurate credit score.

For you the consumer, learning about your credit score and then taking the appropriate steps to keep the numbers high would put you in the category of consumers considered low or no risk.  The three-digit credit score generated uses a unique mathematical algorithm or formula.  In the case of FICO, five criteria are used to include payment history, which accounts for 35% of the score, amount owed to creditors at 30% of the score, length of credit history for 15% of the score, types of credit at 10%, and finally, new credit, also accounting for 10% of your credit score.

VantageScore 2.0 uses the same criteria to generate a credit score as FICO does but the difference is the actual score, which would be unique.  Since this credit scoring system is designed so each credit bureau can maintain its own consumer credit files, which would more than likely vary, the three digits generated would be different from FICO.  With this system, creditors would have the ability to choose the credit reporting agency to where they would provide consumer information.

Check Your Credit Score

With this, it is easy to see that being late on payments would have a major impact on your credit score, along with the amount of credit owed to various creditors.  Although all five criteria play a role in how your credit is rated, knowing the two most critical factors gives you an advantage in allowing you to avoid sending in payments late or spending more than you can afford.  This formulate is not difficult to understand and by following it in the way you make purchases and manage your credit accounts would be the difference in you being given a high or low credit rating.

The five criteria used contain subcategories of information that once input into the credit scoring system would be compared to the information of literally tens of millions of other debtors.  By the scoring system using precise information and comparing you to other debtors, the score generated is extremely accurate to show how likely it is you would manage your credit responsibly.  These three little numbers are what dictate whether you would be approved for a home loan, car loan, motorcycle, loan, personal loan, etc, or be approved for a credit card, charge card, or other revolving credit.

While this is important, considering other uses for your credit score makes proper management of your accounts even more critical.  For instance, being protected by the Fair Credit Act, both insurance companies and employers are allowed by law to pull a copy of your credit report from all three reporting agencies (Equifax, Experian, and TransUnion), without your approval or knowledge.  To understand just how relevant this is, consider the following scenarios.

Your Credit Score and Insurance Premiums

Needing to renew an insurance policy for your car, you call the insurance company or agent that has provided coverage on your vehicles for  years, discuss the type and amount of coverage needed, and then you go home to wait for a phone call to learn the new amount of the premium.

Not giving the process any further thought, you are shocked when your insurance company/agent phones to tell you that a) your premium has increased by 30% or b) they can no longer cover you.  The reason – after running your credit report it was discovered your credit score was too low to qualify according to company policy.

Your Credit Score and Employers

After being out of work for the past six months, the victim of the recent financial crisis, you begin to process of submitting resumes and setting up interviews.  However, even with a college education and years in the workplace, you are surprised that you are not being called back for second interviews and even worse, not being offered jobs.

Finally, you ask one of the employers most interested in working for why you were not considered for the job only to be told your credit score was the determining factor.  Although the negative report was the result of being out of work for six months and a few payments being late and spending high, to potential employers, you appeared as a risk.

Both the insurance and employer scenarios are all too real.  Although for years a credit score was used primarily for determining creditworthiness specific to loans and revolving credit, today this score is more widely used, which means other areas of life are impacted, positively or negatively.  Now, these three generated numbers are now seen in an entirely different light, one that shows just how critical it is to be responsible for all credit accounts.

The way the scoring system is setup is with the lowest possible number being 300 and the highest number 850.  Obviously, the higher the score means the better the rating.  To be offered the lowest interest rates, lowest fees, and most favorable terms for loans, credit cards, and other forms of credit you would need to stay above 720.  Today, most Americans carry a credit score that ranges from 600 to 800 but we wanted to provide a breakdown by credit score versus percentage of people in the United States with that score, as well.

•    499 and Below – 1%
•    500 to 549 – 5%
•    550 to 599 – 7%
•    600 to 649 – 11%
•    650 to 699 – 16%
•    700 to 749 – 20%
•    750 to 799 – 29%
•    800 and Higher – 11%

To understand what a credit score of 520 would get you on a mortgage loan versus a credit score of 720, consider this.  For a 30-year mortgage on a $100,000 home, the difference in points would be 3.45%.  Okay, that does not sound too bad.  Well now, what this means at the maturity of the loan is that with a credit score of 520, you would have paid an additional $85,000 in interest than if you had been rated with a credit score of 720.

Let us look at this scenario in another way.  If you had a credit score of 520, your monthly mortgage payment on a $100,000, 30-year mortgage would be $235 more.  With the current economy still being extremely tight, for most people paying that much extra in the monthly mortgage payment would put a serious bite in the budget.  Remember, this is interest on top of the overall cost of interest accumulated and paid by the end of the loan.

As you can see, this 200-point spread is significant and considering that the average home price in the United States is now at $264,000, even with home prices down, it is easy to do the math.  Seeing the difference you would pay for interest at loan maturity and the increase in the monthly mortgage payment for a credit score of 520 and 720 just became more serious.  Therefore, if interested in purchasing a home, it would be worthwhile to spend six to twelve months prior cleaning up your credit history.  Of course, a good versus excellent credit score would be the same regardless of the type of loan, as well as credit card or other revolving credit.

Credit is no laughing matter but a very serious issue that could enhance your life or leave you in a horrible position.  If you have experienced a tough financial situation, whether one caused by financial mismanagement or something completely out of your control, you should know that even extra bad credit can be corrected although it would require one to two years, hard work, and dedication.  In exchange, you would be given the opportunity to take out loans, secure credit cards, rent homes, buy insurance, pay low insurance premiums, and go to work for a great company.

The process would start by ordering a copy of your credit report from all three credit bureaus.  Keep in mind that any time you are denied credit, by law you are entitled to a copy of your credit report at no cost, as long as the request is made within 60 days of denial.  In addition, consumers in the United States are allowed to order a free copy of each report once every 12 months.

We cannot stress enough that even if you checked your credit report the prior year and have managed all your accounts according to terms, always take advantage of this once-a-year free report because errors can appear for a variety of reasons.  In fact, statistics show that 89% of Americans have at least one error on their credit report.  An error could be the result of incorrect data input, a mix up in accounts by a creditor, a creditor failing to report updates on accounts, and so on.

Credit Score Repair

After receiving the credit reports, you would need to work on both the original and a copy.  Go through each line item and with a yellow highlighter begin marking through everything that needs to be corrected, doing this on the original report, as well as the copy.  Remember, you would be highlighting obvious mistakes such as:

•    Accounts paid in full still showing owed balances
•    Accounts that do not belong to you
•    Accounts with incorrect balances
•    Accounts in collections that are actually in good standing
•    Misspellings on your name, address, employer, etc
•    Incorrect employment information
•    Incorrect residence history

In addition to the above examples, it would be just as important to create a list of any omissions.  As an example, if you had a loan or credit card that had been paid off, one open but in good standing, etc, but it is not showing on the report, you would need to put it on the list.  If you had worked for a specific company for a lengthy timeframe but it was not reported, again, you would add this to the list.  Sometimes, omissions can help improve your credit score to the same extend that mistakes and erroneous information could cause your credit score to plummet.

To complete the process, if anything being reported needs documentation for proof, you would need to get the paperwork in order.  For instance, if a creditor was reporting one of your credit cards having an open balance and no payment made for months when in truth, the credit card balance had been paid off months prior and closed, you would need to contact that creditor to get the issue resolved, followed by asking for a letter confirming the facts.

After gathering all the supporting documentation in order, highlighting mistakes on the original report and copy, and creating a list of omissions, you would take a copy of the documentation and list of omissions to keep for your records along with the copy of the highlighted report.  Then, a letter not more than one page would be written to the respective credit bureau explaining the reason for sending the packet.  The letter should be brief, simply stating that errors and/or omissions had been identified on your credit report, thereby affecting our credit score and that you had provided the necessary information to have the report corrected.  Copy the letter and add it to the stack of other documentation.

When mailing the packet, always send it certified and return receipt requested.  That way, you have proof the information had been received, as well as the name of the person who accepted it.  All three of the three credit bureaus are required to verify the requested changes and by law, have up to 30 days to complete the confirmation process.  Once it is understood the changes to make, the credit bureau would make the corrections and send an updated copy of the credit report to you.  Often, the changes are complete as requested but sometimes, to get your report accurate this process would need to be completed more than once.

After your credit report is accurate, your credit score would automatically go up.  As far as how much the improvement would be depends on the types of mistakes and omissions.  Following the five criteria listed toward the beginning of this article, you would have a good idea whether the changes would make a small or large difference.  For instance, if the majority of mistakes on your credit report had to do with late payments and dollar amount owed, the increase in your credit score would be substantial but if the changes had to do with misspellings of information, a missing employer, etc, your credit score would not change much.

The bottom line is to maintain the best credit score possible through proper account management, as well as taking advantage of your annual credit report to keep your credit score high.  The result – greater buying power, respect, and better opportunities than someone with a poor credit score.