Credit Score 101

The first thing to know about the credit score it that it is a complicated matrix on which an action, like opening a credit account, can impact one consumer's score quite differently from another depending on a myriad of factors. In a sense, your credit score is like a delicate ecosystem where a change in one element impacts everything else. But, as with any ecosystem, there are certain fundamental things it requires to be healthy.

Payment History

Your payment history is 35 percent of your credit score, according to the Fair Isaac Corp., which devised the credit score. It takes into account the number of payments you've made on time, the number of accounts you've paid as agreed, the amount past due on delinquent accounts and how long they've been past due. It looks at adverse judgements such as collections and bankruptcies. The farther collections accounts and bankruptcies are in your credit past, the less weight they hold in determining your score.

Amounts Owed

How much you owe is worth another 30 percent of your FICO score. This is also referred to as credit utilization. The score looks at how much money you owe, especially compared to how much credit has been extended to you. It looks at how much you owe on installment loans, credit cards, mortgages and other loans and what your original balance was. The score favors creditors who have low balances on several loans rather than a high balance on one. It would be likely to rate a consumer higher, for example, for having three loans and owing 20 percent of the credit extended on each rather than one credit card with 60 percent of the balance due.

Length of Credit History

The scoring system wants to see that consumers have shown a history of managing credit responsibly over time. It rates consumers more highly who can show through mortgages, credit cards, installment loans and other credit vehicles a history of managing credit and making payments faithfully. Fifteen percent of a person's score is credit history. By the same token, 10 percent is new credit which includes number of new accounts opened, numbers of times creditors have asked for your report because you applied for new accounts and how quickly you reestablished good credit after past credit problems. It's a red flag if you're applying for lots of new credit but if you're car or house shopping, all inquiries within a two-week period only count as one inquiry.

Types of Credit Used

This looks at what kinds of credit you have. Mortgages, auto loans and other secured loans are looked at more favorably than unsecured credit. In fact, consumer loans are also scored less harshly, according to Liz Weston of MSN Money.

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How to Freeze a Credit File

If you have been a victim of identity theft or fear you may become one, you may wish to freeze your credit file. When you freeze your credit file with one of the three credit-reporting agencies, your file is available to others only with prior, written permission. You can request a temporary lift of the credit freeze if you are going shopping and wish to allow lenders to access your credit file. After this temporary lift, your file will again be frozen. Requesting a credit freeze will require you to contact a credit-reporting agency.

Instructions

1

Call the credit-reporting agency from which you want to request a credit file freeze (see the Resource section for a list of numbers). Ask to be transferred to the department that handles credit file freezes.

2

Give the agent the reason you are requesting the credit file freeze. The agent needs to verify your identity by asking for your name, Social Security number, address and date of birth. She may also ask for information about some of your credit file accounts. You may also be asked to fax proof of your identity, such as a utility bill showing your name and address or a copy of your driver's license.

3

Make note of the information provided to you by the agent, including a password code required anytime you wish to access your credit file or thaw the credit file. Save this important information in a safe place. If you have been a victim of identity theft, you should not be charged for the credit file freeze. As of June 2010, you may be charged $3 to $10 depending on the credit-reporting agency if you are not a victim of identity theft.

4

Ask the agent for details on how to thaw your credit file. Ask about the specific process, including how many days' notice are needed to unfreeze your file and where requests need to be mailed.

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What Is a Derogatory Account?

Your credit report contains information about your currently active credit accounts as well as accounts you held in the past. When your creditors notify the credit reporting agencies about negative information related to your management of a particular account, credit bureaus notate that information on your credit file. Accounts on which negative information exists are commonly referred to as derogatory accounts.

Credit Bureaus

The three credit reporting bureaus, Equifax, Experian and TransUnion, all use different formulas for calculating your credit score and produce credit reports that contain the same general information but presented in a different format. However, each bureau's credit report template specifies the number of derogatory accounts that you have listed on your report. When you apply for a new credit account, the lender can decline your loan application based upon the number of derogatory accounts you have.

Derogatory Accounts

Derogatory accounts take many forms but range from mortgages that ended up going into foreclosure to credit cards on which you made one late payment. Late payments are only listed on your credit report if you fall more than 30 days behind on your payments. Several late payments have a less damaging effect on your credit score than a major event like a car repossession or foreclosure. Other derogatory accounts you may see on your credit report include overdrawn deposit accounts that you failed to settle.

History

A derogatory account typically stays in your credit report for up to seven years. Bankruptcies are not technically accounts but are still classified as negative credit events and can remain on your credit report for up to 10 years. However, credit scores are more tilted toward recent events than past account history. Therefore, while derogatory accounts continue to appear on your credit report for many years, how you manage your active accounts has more of an impact on your credit score.

Errors

On occasions, credit reporting agencies receive inaccurate information from creditors and data collecting agencies. When you are declined for credit based upon derogatory information listed on your credit report, you are entitled to obtain a free copy of that report. You must submit your request for a copy of your report within 60 days of being denied credit. Upon reviewing the report you have the right to contest any inaccurate information related to derogatory accounts on your report. Credit bureaus must respond to correspondence relating to credit reporting inaccuracies within 30 days of receiving your complaint and take steps to rectify your credit report.

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How to Run a Canadian Credit Check

In Canada, knowing your credit history is vital. Having established credit allows consumers to purchase items on credit without having to pay the entire amount upfront. Credit can allow you to obtain a mortgage on a home, a loan on a car or get a utility bill put in your name. As an employer, knowing the credit history of current and potential employees is an asset. For these reasons, your credit rating is extremely important to both you and your present or potential employer.

Instructions

Obtaining your personal credit report

1

Select two pieces of government identification. These may include a birth certificate, passport, age of majority card, citizenship card, social insurance card, aboriginal status card, military card or any other government issued identification. These two pieces combined must have your name, date of birth, signature and current address.

2

Download the appropriate request form from TransUnion Canada, Equifax Canada or Experian Canada (see Resources).

3

Complete all required information on the form.

4

Photocopy required identification (both sides), and send it with the form to the address indicated.

Running a Credit Check on a Canadian Resident

5

Register with a credit agency: TransUnion Canada, Equifax Canada or Experian Canada (see Resources).

6

Prepare a form for the customer to sign, allowing access to their credit information.

7

View and photocopy one piece of identification and verify that the information on the form is correct and in accordance with the identification.

8

Submit the information to TransUnion Canada, Equifax Canada or Experian Canada, and request a history of credit.

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How to Get a Better Credit Score

One of the most important numbers in your life besides your social security number is your credit score. The higher the score the better your ability to get a loan for a house, school tuition, car or other purchase. Your credit score tells lenders about your financial history and your ability to pay back a loan. A good credit score also gets you lower interest rates. While you cannot improve your credit score overnight, you can improve it within a month a two.

Instructions

1

Pay bills on time. This shows financial responsibility. If you think you will be late with a bill, talk to your creditor and make payment arrangements. Also ask that the late payments not be reported to the credit agencies. If you are already late with a payment, try to pay as soon as you can or speak with the creditor to explain the situation. Don't ignore late bills. Let your creditor know you are aware that you are late. A creditor may be more willing to work with you.

2

Reduce credit card balances. When considering you for a loan, a lender looks at your credit limit and you balance. Try to keep you balance at 25 percent of your limit. Paying more than the minimum each month will lower your balance at a faster rate.

3

Get copies of your credit reports. Each year you are entitled to one free copy of your credit report from each of the three credit reporting agencies, TransUnion, Experian and Equifax. After you get the report, read it carefully. If you find mistakes, contact the agency using either form provided or by phone. Each agency must investigate any items in your report that you dispute. If the agency agrees that an error has been made, the dispute item will be removed from your credit report. If you do not agree with the agency's finding, you have a legal right to add a brief note to your credit file explaining why you believe the item is in error.

4

Don't try to get more credit. One thing that will lower your credit score is applying for new credits card or loans. Too many inquiries on your credit report send up red flags with creditors. If you expect to apply for a loan for a major purchase, it is best not to apply for new credit the six months leading up to your loan application.

5

Don't consolidate your debts. Pay off the balances on your loans or credit cards instead of consolidating them into one large loan. Your credit score will be lowered if you have the same amount owed but on fewer accounts. Lenders look at the ratio of balance to limit when determining if you are a get risk for a loan.

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FICO Debt-to-Credit Ratios

Consumers use credit in a variety of ways. When a lender extends credit to you, that credit account is reported to the credit bureaus. Such information is distilled into a credit report. According to MyFico, your FICO credit score ranges from 300 to 850 and is directly based upon the data in your report. It's important to understand how debt impacts this score.

Identification

Your FICO credit score is determined by a mathematical algorithm that translates the data on your credit report into a three-digit number. The score looks at five areas: 35 percent is how well you pay your bills, 30 percent is how much debt you have, 15 percent is the average length of your credit history, 10 percent is the amount of new credit you've applied for recently, and the last 10 percent reflects the mix of credit found on your report.

Significance

The second largest factor in your credit score is how much debt you have. For this factor, FICO measures your debt-to-credit ratio, also known as your credit utilization ratio. In essence, this compares how much debt you have versus how much available credit you have. The more available credit you have, the lower this ratio and the higher your score. Conversely, the less available credit you have, the higher this ratio and the lower your score.

Considerations

How you use your credit cards can directly affect your FICO credit score. Since your FICO score measures your credit utilization ratio, maxing out a credit card will decrease your credit score. The reason is because if you use up your entire credit limit, that decreases your available credit while increasing the amount of your debt. According to Bankrate.com, a maxed-out card can lower your score by up to 45 points. A lower credit score can put you at risk for higher interest rates on other types of credit that you apply for.

Prevention/Solution

Lowering the amount of debt you have will gradually increase your score. According to MyFico, to improve your score you should keep balances on revolving credit, such as credit cards, low. Pay down the debt instead of using balance transfers. Transferring the balance doesn't eliminate the debt; it simply moves it around from one card to another. Decreasing the number of credit accounts that you have without decreasing the amount of debt may actually lower your score, according to MyFico.

Warning

Be careful when closing credit cards. Remember, 15 percent of your FICO score measures the length of your credit history. Closing a card, especially an old credit card, will shorten the length of your credit history, and that may lower your score. The longer your history is, the higher your score. Also, according to MyFico, don't open new credit accounts just to increase your available credit and improve your score. The opposite may happen because each new account decreases the average length of your credit history and this may drop your score. How much it drops depends upon the other factors present within your report.

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5 Steps to Building Credit

About 50 million people in the U.S. have no credit history, but most of these people can obtain some kind of creditable account, according to Lynnette Khalfani-Cox of Wallet Pop. The most important step to building credit is to open an account tracked by the major credit bureaus. Then you only need to pay your bills on time and keep your debt load small.

Check Your Credit Report

You may already have a credit history and not know it. If you have ever had a credit card, mortgage or any bank loan, your lender likely reports the account to the major credit bureaus. If you have bad credit and want to rebuild your score, check your report for weak areas in your finances. For example, if you see a high utilization ratio -- portion of your credit limit available -- funnel money into credit-card payments.

Budgeting

You cannot build good credit unless you have control of your finances. If you have an ever-increasing debt load and frequently miss payments, you need to adjust your budget to accommodate your life style. Go to a credit counselor if you cannot figure out a way to pay for your debts and essentials with your income. You may have to give up some luxuries, such as eating out and vacations.

Open New Accounts

Whether you have bad or no credit, a new credit account can help you build a good score, because the FICO scoring model gives you points the more accounts you have with a perfect history. Gas and retail cards have the most lax lending standards, but also have low limits and high interest rates and fees. A secured credit card almost guarantees you approval, because you secure the limit with a bank deposit. However, you also have to use these accounts. You only need to make a small charge, such as paying a phone bill, and pay it off so the lender can report something to the credit bureaus.

Beyond Credit Scores

Lenders may reject your loan applications even with a great credit score, because they factor in other variables into their lending decisions. For example, most lenders do not approve mortgages for people who have been at their job for less than two years or have large gaps in their employment history. Also, try to stay in the same state and keep the same telephone number, because the credit bureaus track demographic data, even though this data does not affect your credit rating.

Considerations

Recovering from bad credit can take months and years. If you have no credit history, the bureaus need about six months of data before they report your accounts and calculate a score, according to Khalfani-Cox. However, if you keep paying bills on time and eliminate as much debt as possible, you eventually will have at least an average score of 620.

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