NORTHWEST SMART MONEY TOOL TIP:
Understanding, Improving and Maintaining Your Credit Score
First things first: What is a credit score? A credit score is a number that is used to predict risk for lenders. To create a credit score, analysts use information in credit reports, account histories or applications. Their goal is to accurately identify the consistency of your timely paid accounts as well as your delinquent accounts. The result of this analysis is a number that becomes your credit score.
Lenders use credit scores to help decide whether to issue accounts or loans, whether to change the credit limit on an existing account and what interest rate to charge on a new or existing loan, among other things. Insurance companies use insurance scores (which are based on credit information, but calculated somewhat differently) to help them decide whether to issue new auto or homeowner’s policies, what rate to charge for those policies and whether to renew existing policies. Some employers use consumer scores (which are also based on credit information) to help them make hiring decisions.
There are different types of scores; Fair, Isaac and Company, Inc. develops many of them. These are commonly referred to as “FICO scores.” It’s important to understand that your credit score is never a single number. It can vary, depending on which of the three major credit bureaus supplied the credit information used to calculate it, what kind of loan is being considered and what formula the individual lender uses to calculate it. For example, mortgage lenders typically request a “tri-merge” credit report, which includes credit information and scores from the three major credit bureaus—Equifax, Experian and Trans Union. Typically, the credit score from each of those bureaus will vary, so the lender will use the score that falls in the middle of the three when evaluating the loan.
Some things to keep in mind about your credit score:
- Your credit score can change frequently as information is updated in your credit reports.
- Lenders may use different credit scoring formulas that are customized for their loan products when calculating your score.
- Credit scores are calculated using the information in your credit report, even if that information is not correct.
- With a FICO score, the higher the number, the better the score.
There are five factors that go into a credit score, but they are not all weighted the same. Your payment history accounts for 35% of your score; amounts you owe relative to your income, 30%; length of credit history, 15%; new credit, 10%; and type of credit in use, 10%. The two most important factors that go into your credit score are your payment history—whether you’ve paid your bills on time—and the amounts you owe—how much debt you carry. Together, these categories make up about two-thirds of your credit score. That means if you want to improve your credit score, focus on paying your bills on time and paying down debt.
The first step in improving or maintaining your credit score is to understand what’s on there now. Each of the three major credit bureaus—Equifax, Experian and Trans Union—is separate, and they don’t share information with each other, so it’s a good idea to order a report from each one. Many apps and websites now offer free credit reports that you can access at any time. As you review your credit report, look for the following potential problems:
- Mistakes in personal information, including name (and variations), Social Security Numbers or addresses.
- Mistakes in account listings. Look for late payments that aren’t correct, outdated balances, duplicate listings of the same account, or other mistakes.
- Negative items including bankruptcies, judgments, liens, collection accounts or late payments.
- Inquiries from companies you don’t recognize. When a company reviews your credit report, it creates an inquiry. While they may be legitimate, inquiries into your report from companies you don’t know can sometimes indicate fraud.
The next step is to understand how long information can be reported. The first thing most people with bad credit want to know is, “How long can this information haunt me?” Under the federal Fair Credit Reporting Act, credit reporting agencies are not allowed to report any information that is too old, incomplete, or wrong. While positive or neutral information can be reported indefinitely, negative information can only be reported for a certain length of time, depending on the type of information. As a general rule, adverse information, including late payments, stays on your report for seven years. Adverse information is any data that may cause an unfavorable result for the consumer; for example, being turned down for credit, employment or insurance or being charged a higher rate than applied for in the case of credit or insurance.
An important part of reviewing your credit report is to dispute mistakes. You can do this by contacting the lender, court or collection agency (furnisher) reporting it and ask it to investigate, or by contacting the credit bureaus that have the information that is wrong and ask to verify the information. When the credit bureau or furnisher receives your dispute, it usually has thirty days to investigate and get back to you with the results. If you disputed the information through the credit bureau, it must provide you with a free credit report showing the updated information, if corrections were made. If information is removed because you challenged it with the credit bureau, the bureau cannot add it back to your credit report without first certifying with the furnisher that it is correct. It also must notify you in writing first that it will be adding it back to your report.
Something to note: Don’t assume that seeing old accounts listed on your report is a mistake. Many consumers who review their credit reports find old credit card accounts they haven’t used for years still listed as open accounts. You may think it’s a good idea to close those accounts and have them listed on your credit report as closed, but Fair Isaac Co. says that closing old accounts can’t help your FICO credit score, and can actually hurt it. Credit scores are based on information about how you’ve handled different types of credit over time. When you close out a lot of accounts, you may limit some of the information that could be helpful in predicting how you’ll pay in the future. You may also shorten the average length of your credit history. When it comes to credit scores, a longer credit history is better. Unless you have a specific reason for closing accounts—you’re getting divorced, for example, and want to close your joint accounts—you may want to leave your old accounts as they are.
You may find that your credit report contains information that is negative, but correct. If this is the case, you’ll want to work on improving your score. You won’t build better credit without positive credit references on your file. It’s not important to carry debt to build better credit, but it is important to maintain good credit accounts. Ideally, your credit report should show three or four active accounts (including credit cards, a car loan and/or a mortgage) paid on time each month. If you use credit cards to rebuild your credit, it’s to your advantage to pay the balance in full each month and avoid interest charges.
A credit counseling program can help you get back on track by negotiating a payment plan with reduced interest and/or fees with your creditors. Credit counseling can improve your credit rating if you work with a reliable agency because you’ll reduce your debt, and many creditors will remove late payments just prior to when you entered the counseling program if you stick with it. But! Beware of companies that prey on people with damaged credit ratings. Be very careful with offers such as: guaranteed credit cards, advance loans for an upfront fee or credit repair companies. According to the Federal Trade Commission, you should beware of companies that: want you to pay for credit repair services before any services are provided; do not tell you your legal rights and what you can do yourself for free; recommend that you not contact a credit bureau directly; suggest that you try to invent a “new” credit report by applying for an Employer Identification Number to use instead of your Social Security Number; or advise you to dispute all information in your credit report or take any action that seems illegal, such as creating a new credit identity.
If you’ve had credit problems in the past, you probably feel frustrated and worried that your damaged credit history will stay with you forever. In almost every case, however, there are strategies you can use to put your credit back on track. If you actively work on improving your credit, you will see results. It may not happen as quickly as you hope, but it all depends on your situation—and the time and effort are certainly worth it. Now that you know the basics of credit reports, how your scores are calculated and what to do with negative and incorrect information, it’s time to start improving your score!