Determining the creditworthiness and potential risk of a credit applicant is the major function of a credit score. This three-digit number is a key factor for interest rate assignment and credit applicant approval. The score is dynamic and changes monthly and even weekly. Many factors support the assignment of a credit score, so consumers need to be aware how their financial actions impact their score. Obtaining a copy of the credit report is the first step in understanding credit and improving the score if needed.
FICO Score
FICO stands for Fair Issac Corp., the company responsible for creating the FICO score in the 1980s. The FICO score ranges between 300 and 850 points. Scores over 650 represent better creditworthiness in the eyes of lenders. Scores in the lower range indicate high risk and can lead to rejected credit applications or high interest rates. The FICO score consists of five parts; payment history, account balances, length of credit history, new credit and other factors (i.e. mix of credit types). The payment history carries the most weight, 35 percent of the FICO score, while new credit and credit mix each account for only 10 percent of the score.
Credit Reporting Agencies
The individual reporting agencies -- Equifax, Experian and TransUnion -- gather consumer information from credit card companies, banks and lenders. These agencies are for-profit companies and are not affiliated with the government, but they are regulated by the Fair Credit Reporting Act. The three agencies do not exchange credit information so it is important to contact each agency individually to report discrepancies Creditors agree to report consumer information to these agencies in exchange for obtaining information on consumers to assess credit. Each agency calculates credit scores differently so it is possible for a consumer to have three different scores. Most lenders consider all three scores when determining credit decisions, although some only look at one.
Implications
Having bad credit has major drawbacks financially. Home buyers with low credit scores often receive higher interest rates that translate to more money paid over the life of the loan. Utility companies often run a credit check on new applicants, and a low score might mean a higher deposit. Many utility companies do not require deposits from applicants with good credit scores. Missing just one or two payments can cause a drop of 30 points to a FICO score. Having maxed-out credit cards also affects a score negatively. Conversely, paying down credit cards and making on-time payments affect the score positively. Opening new lines of credit affects the score negatively as well, but to a lesser degree. Buying a home will bring the score down initially but over time maintaining the mortgage will add positive value to the credit file since this is usually the largest debt in the report.
Rebuilding Credit
The first step in rebuilding credit after a bankruptcy, foreclosure or other major credit-changing event is to obtain a copy of the credit report. Consumers are allowed one free credit report per year from each agency and can order them by calling 877-322-8228 or visiting annualcreditreport.com. Report any errors on the report immediately and pay bills on time. If possible, pay down credit cards.
Resources
Debt counseling services offer consumers help to conquer debt. Consumers work with counselors to establish budgets and negotiate better terms with creditors. Debt consolidation services allow consumers to pay one fee per month, but these services should be reviewed thoroughly before enrolling because it may be more cost beneficial to pay down the individual debts.
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