The Advantages of Credit Rating Agencies

The major credit-rating agencies serve a vital function for American businesses and consumers. They assess risk in order to curb potential losses that can result from reckless lending practices. The major U.S. rating agencies for business are Moody's Investors Service, Standard & Poor's, Dun & Bradstreet, Fitch Ratings and A.M. Best. Banks rely upon TransUnion, Experian and Equifax in the consumer sector.

Assessing Risk

Banks must have an independent way to determine the creditworthiness of consumers before extending loans and issuing credit cards. The major consumer rating agencies fulfill this role. As for businesses, the same concept applies but with typically larger amounts at stake. Also, as corporations frequently issue bonds to a wide range of investors, the business rating agencies help to safeguard those investments.

Minimizing Loan and Bond Losses

The business and consumer credit rating agencies help to mitigate potentially disastrous losses that could shake the financial system. Banks are able to accurately measure possible losses through the credit scores of consumers. The agencies responsible for measuring them use sophisticated models to predict the likelihood of default. The business rating agencies help to measure the prospect of losses from loans and bonds using similar principles.

Providing Accountability

Our culture of consumption requires money to remain sated, and if those funds are not forthcoming by the traditional work ethic and weekly paycheck, credit has become widely available to pick up the slacks, shirts, televisions, computers, cars, et al. Excess credit can lead to problems with payback, and without the guiding hand of accountability provided by the major credit rating agencies, escalating problems could result.

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How Long Does a Credit Inquiry Affect a FICO Score?

A credit inquiry occurs when a creditor obtains your credit score when it checks your credit. Only credit inquiries that result from you applying for new credit, such as a new car loan, affect your FICO credit score. The FICO score is the most widely used credit score, calculated using the algorithm developed by the Fair Isaac Corporation.

Time Frame

According to the Fair Isaac Corporation, credit inquiries affect your credit score for one year. However, they appear on your credit report for two years.

Features

Certain inquiries may be treated differently than others. For example, if you apply for several mortgages at once, the credit scoring model counts the resulting inquiries as only one inquiry if all of the inquiries occur within a short period of time. This minimized the negative effects on your credit score.

Effects

Credit inquiries decrease your credit score, but not by much unless you have several inquiries in a short period of time. Your credit score falls because statistics show that people with more inquiries are more likely to declare bankruptcy, according to the Fair Isaac Corporation.

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How Will a Child's College Loans Affect a Parent's Credit Rating?

A parent may not think twice about co-signing a student loan to help his child finance a college education, but this could have significant consequences for the credit ratings of the child and the parent. On the other hand, this might help the child begin to build a credit history when he graduates. However, the parent should be prepared to repay the loan if he put his name on it.

Identification

A college loan only affects the parent's credit rating when one or both parents put their names on the promissory note, called co-signing. Once the parent co-signs the loan, the history on the account appears on the credit reports of anyone who signed the document. Often this is a necessary step with private lenders, because they typically require a score of at least 630 to approve a loan for a single borrower, according to the FinAid website. Federal loans almost always require the parent to co-sign the promissory note.

Benefit and Drawback

Co-signing a college loan boosts the parent's credit rating over time if the parent and child meet the agreed upon monthly payment for each billing period. The initial loan application and added debt burden of a student loan usually cause the borrower's scores to drop initially. However, this effect disappears once the account holders establish a good payment history, which may take up to six months. Any negative items, such as a missed payment, bring down the scores of the parent and child.

Considerations

Lenders consider more factors than the credit score when making future lending decisions for the parent. A person's monthly debt compared to his monthly earnings, called a debt-to-income ratio (DTI), carries as much weight as a credit score. The DTI shows the lender the parent's ability to pay a debt, while credit scores indicate his willingness to pay. According to the Moolamony website, most creditors require a DTI of no more than 36 percent, including the monthly payment for the potential loan. Some lenders may accept a DTI higher than 36 percent, however. The Federal Housing Administration, for instance, allows a DTI up to 41 percent, according to Real Estate ABC. Student loans can be for large sums -- sometimes hundreds of thousands of dollars -- which can cause the DTI to rise dramatically.

Tip

The child should seek a loan on his own before involving the parent. Federal loans require a co-signer, but not if the parents have bad credit. Private lenders often set aside a certain amount of loan money for college financial aid offices to let them award loans regardless of the borrower's credit score. If the parent must co-sign a loan, he may try to refinance it when the child is able to qualify for a loan on his own and take full responsibility for the debt. This is the only way to remove a co-signer from a promissory note.

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How Long Do Tax Liens Stay on Credit Reports?

An IRS tax lien can prevent a consumer from getting the financing and credit they need, and it can also mean that the IRS has access to your personal property. A tax lien may sound intimidating, but it is a simple legal process. As long as a consumer understands what a lien is and how to properly address it, then it can be removed from a credit report eventually.

Identification

A tax lien is the way that the IRS can use to collect back taxes that are due. When the IRS files a tax lien, they are able to have an influence over every aspect of your financial life including the ability to secure financing for large purchases such as a house or a car, or the ability to get more credit. Once the IRS is able to put a tax lien on your personal accounts, they can then use that lien to collect the back taxes that you owe.

Significance

The IRS can use a tax lien to seize your personal property to satisfy the back taxes owed. When a tax lien is authorized, the IRS does not need any further authorization to take any personal property that you own to satisfy a tax debt.

Time Frame

A tax lien remains on a credit report, and affects a credit score and the ability to apply for new forms of credit, for 15 years if it is not paid. A tax lien that is paid will remain on a credit report for 7 years after it has been paid. This 7-year period can cause the tax lien to remain on a credit report for more than the original 15 years, or less, depending on when it was paid. A tax lien that is paid after being on a credit report for 2 years will be on the credit report for a total of 9 years. A tax lien that is paid after being on a credit report for 12 years will remain on that report for a total of 19 years.

Considerations

The IRS has 30 days from the date of payment to release a tax lien. However, the IRS can sometimes let this time period lapse without performing the release, and it is the responsibility of the tax payer to follow up and make sure the task is done properly. The IRS offers a toll-free phone number where tax payers that are expecting line releases can call to confirm a lien has been released, or request that a lien that was supposed to be released be investigated.

Expert Insight

According to Credit.com, it is a good idea to obtain a copy of the lien release from the courthouse it was filed in and send a copy to each of the three credit reporting agencies. While the agencies will eventually pick up on the lien release in their normal course of research, it is a good idea to accelerate the process by providing copies of the lien release for the agencies to use in their records. The sooner a lien is off of a credit report, the sooner that consumer can get new credit or financing.

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How to Get a Very Good Credit Score

Getting a solid credit score is not difficult. It is simply a matter of responsibly handling your credit lines and faithfully paying your credit card bills. If you pursue this strategy and more, attaining a desirable credit score becomes just a matter of time.

Instructions

1

Obtain a copy of your credit report. You can get a free report annually from each of the three credit agencies (see Resources). Review each report, checking for any inaccurate or negative information as well as errors. Dispute any incorrect information in writing or online to Experian, TransUnion and Equifax.

2

Pay your monthly credit card bills on time and miss no payments. Pay at least the minimum balance. When you establish a record of reliability, it sends a very good message and increases your credit score.

3

Do not close long-held credit accounts in good standing. Having a longer credit history can score you points because it shows stability. Closing accounts can decrease your credit score because you are showing less available credit.

4

Do not open new credit card accounts you will use only infrequently, such as retail store accounts. Although the stores commonly offer 10 to 15 percent off present purchases, opening an account with them can negatively affect your credit score.

5

Avoid maxing out any cards. Keep credit used to about 30 to 33 percent of the limit. If it is already close to the limit, it is wise to pay as much as possible to get it reduced.

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Individual Credit Solutions

Improving your individual credit score helps you get financing without the assistance of a co-signer, who is someone with good credit who agrees to apply for a loan with you. Bad credit can result from delinquencies, excessive debt and other poor habits. But solutions can help fix credit problems and slowly increase your score.

Credit Delinquenices

A major key to solving personal credit problems is changing the way you manage your bills with creditors. Every late payment and every missed payment shaves points off your personal credit score. And if you continue to pay bills late or completely default on credit cards and loans, your score will drop and stop you from getting future financing. Managing credit and paying bills necessitates a measure of organization and good budgeting. Plan purchases in advance, and review how much you can afford to spend on extras such as a entertainment. Pay priority bills first, and if you have disposable income, spend this income in moderation and keep some for savings. If necessary, schedule automated bill payments to avoid lateness.

Lower Debt

Excessive spending can bring on high credit card balances, and carrying huge balances also hurts your individual credit score. Solve credit problems related to debt by using cash instead of credit, and resolving to keep your balances to a minimum -- less than 30 percent of your credit limit. Tips to help solve debt include paying more than your minimum, taking money from savings to completely eliminate the debt, and, if you use credit, paying off new charges every month.

New Account

Open new credit accounts with care, and don't send in several credit applications within a short period. Looking for the best rate on a car loan or mortgage loan are good reasons to shop around and contact multiple lenders; these inquiries don't affect credit scores as badly as applying for multiple credit cards (bureaus view shopping for loans as one inquiry). On the other hand, regularly applying for pre-approved credit cards or frequently submitting applications for store credit can take points off your score and stop efforts to increase your score.

Discuss Financial Problems

Creditors and lenders are here to help you. Rather than let financial problems or other issues affect your good standing with the company, contact your creditors and lenders for assistance if you can't make a payment because of unemployment or because you're taking time off from work to deal with an illness or injury. Mortgage companies offer loan modifications and forbearance options to eligible borrowers, and many other lenders permit skip-payment options to assist borrowers in distress.

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What Are the Benefits of a Good Credit Score?

Your credit history is shaped by a number of factors, such as how much of your available credit you use, whether you make payments on time and whether you've been through a bankruptcy or a foreclosure. Rather than analyze every wrinkle of your credit, lenders may look up your credit score, which combines all the details of your history into a single number.

Formula

The Fair Isaac Corporation developed the concept of credit scoring and the software and systems to do it, which is why your score is often called a "FICO" score. While FICO doesn't divulge its exact credit-score formula, it does identify the key elements of your score: 35 percent payment history, 30 percent the amount owed, 15 percent length of credit history, 10 percent new credit and 10 percent the type of credit used. The formula may be adjusted in certain situations, for example if you've only started using credit recently.

Benefits

Having a good credit score indicates you're a good credit risk. That means it's safer for lenders offer you more credit, such as a mortgage or a new credit card, at a low rate of interest. If you have excellent, credit and you qualify for Federal Housing Administration mortgage insurance, you may be able to buy a house with only a 3.5 percent down payment. Another advantage, FICO states, is that your score reflects your overall credit history: It averages good reports and bad rather than letting a few bad mistakes blacklist you.

Numbers

If you have a score above 760, Dana Wood says on the Real Estate News website, you're in very good shape: If you're mortgage shopping, for instance, you can expect multiple offers with good terms from lenders. If your score ranks below 620, you're considered sub-prime; you'll have higher interest rates and less room to negotiate. The range between 620 and 760 is the domain of the average borrower. You might think that higher is always better, but if you're already above 760, you're unlikely to get a better deal even if you push into the 800s.

Information

You can order a free report from each of the three main credit bureaus -- Equifax, Experian and TransUnion -- once a year from the Annual Credit Report website (see Resources). You can also obtain your credit score through the website, but you'll have to pay for it. The bureaus also offer their own proprietary scores to lenders, using their own systems, so it's possible that the credit score your lender orders won't be exactly the same as the one you get.

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How to Create a CPN Number

Credit profile numbers are often promoted as a way to get a fresh start and have a brand new credit score. However, the law is meant to protect the privacy of those who do not want their identity stolen. The CPN number is only used for credit profiles and is not a Social Security number substitute. The number was a creation of the 1974 U.S. Privacy Act Title V, which prevents banks from denying you credit because you refuse to share your Social Security number.

Instructions

1

Formulate a rationale for needing a CPN number. The law allowing for the creation of a CPN is considered a "loophole," and the credit bureaus and banks are working to prevent people from abusing the ability to get multiple CPN numbers and using lines of credit they don't intend to pay back.

2

Contact an attorney to help you navigate the process of obtaining a CPN. People on the Internet are often scamming people by getting them to pay huge fees for CPN numbers that turn out to be unusable. Hiring an attorney will help to increase the probability of obtaining a CPN number and not subjecting you to potential legal consequences from the process.

3

Instruct your attorney to follow all applicable laws and to make sure he contacts the Social Security office. This will help alert the authorities to what you are doing and your rationale behind it.

4

Be prepared to follow up on any questions that may be asked of you by the federal government or credit bureaus about your intentions behind obtaining this number. Always consult your attorney when dealing with those authorities.

5

Use your CPN number only when necessary. Opening new lines of credit and avoiding problems you may have had with credit using your Social Security number is not how a CPN should be used. Debts incurred by a person are always the responsibility of the person using the lines of credit.

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Secrets to Boost Your Credit Score

While different formulas exist for calculating your credit score, all credit scoring algorithms use the current and past account information contained within your credit report to determine your credit rating. Your credit score will naturally improve over time if you practice good debt management habits and pay your creditors in a timely manner. There are, however, actions you can take to boost your credit score more quickly.

Increase Credit Limits

If you carry credit cards or other open lines of credit that appear on your credit report, asking your creditor to increase your credit limit has a positive effect on your credit scores. Your credit utilization ratio -- the amount you owe on your credit lines as opposed to your spending limit -- is one factor the credit bureaus consider when determining your credit score. The greater the difference between the two numbers, the better your credit rating.

To glean the greatest benefit from a higher spending limit, simultaneously pay down your balance. This further increases your credit utilization ratio -- improving your credit score.

Write Goodwill Letters

Making a single payment 30 days late to one of your creditors can cause your credit score to drop by 100 points or more, depending on your current credit rating. Fortunately, creditors have the ability to amend negative reports they file with the credit bureaus. Unless you ask your creditor to do so, however, it has little incentive to help you boost your credit score.

A goodwill letter is a formal request to a creditor to delete its late payment notations from your credit record. While your creditor may not amend your files in response to a goodwill letter, you have a higher chance of success if your late payment was an isolated incident and you are a longstanding customer.

Delete Obsolete Information

The Fair Credit Reporting Act holds each credit bureau responsible for deleting information from your credit record once that information becomes obsolete -- usually after seven years. Oversights on the part of the credit bureaus when deleting negative credit information aren't uncommon and can result in your credit score reporting as much lower than it should be. Check your credit reports for derogatory accounts, such as charge-offs and collection records, older than seven years. Dispute any obsolete information you find for a boost to your credit rating. Should you come across any other reporting errors when reviewing your file, you can dispute those as well.

Add Positive Information

Landlords and utility companies do not always report positive accounts to the credit bureaus -- but that does not mean that they cannot do so. Ask your utility companies or landlord to report your positive payment history on your credit report. The more positive accounts that appear on your credit report, the higher your credit score will climb.

If your landlord or utility companies cannot report your payments on your credit report, you can also add positive payment history by asking a loved one with good credit to add you to his credit card account as an authorized user. Once added, your loved one's beneficial payment history appears on your credit report and the credit bureaus will factor it into your overall credit score.

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How to Fix My Credit After a Vehicle Repo

Lenders providing car financing usually include provisions in their contracts permitting vehicle seizure when borrowers miss a payment, according to the Federal Trade Commisson (FTC) website. This action is known as a vehicle repossession, and it remains on Experian, Equifax and TransUnion credit reports for seven years. Thus, a repossession lowers your credit score, making it more difficult to get other loans; however, you can mitigate the damage with some repair work.

Instructions

1

Send payments to catch up any other accounts with past due balances, recommends the My FICO credit score company website. Delinquent accounts and other payment-related information count for more than one-third of your credit score. Late payments hurt you, but the way to rebuild your credit is to bring your accounts current and make all future payments on time.

2

Pay any difference between the amount you owed on your repossessed vehicle and the amount the bank received from its sale. This is called the deficiency, according to the FTC website, and you are liable to pay. The unpaid balance hurts your credit score because it is viewed as a payment delinquency. The damage gets worse if the bank charges it off and sends it to a collection agency or sues you and get a judgment from the court.

3

Clean as many negative accounts off your credit reports as possible. The FTC website advises ordering credit reports from annualcreditreport.com. The Fair Credit Reporting Act (FCRA), mandates this site, which gives a free report every 12 months. Find entries with errors and dispute them with the credit bureaus. Divorcenet, a legal website, explains that the bureaus must erase the information if it the reporting creditor cannot verify the information.

4

Buy things with your other credit accounts, but only spend as much as you can afford to pay back promptly. MSN Money website writer Liz Pulliam Weston explains that you need to use credit to fix your damaged history. Get a secured credit card if the repossession was not your only problem and your creditors closed your other accounts. You put money in a bank account, and the card issuer extends a credit line for the deposited amount, which acts as collateral.

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How to Remove Obsolete Credit Information

It's always a good idea to check your credit reports to see what information about you is being displayed. Lenders and other companies interested in your creditworthiness will check your credit history to see whether or not you are a good risk. If any information is obsolete, you can request that it be removed from any or all of your credit reports. This will ensure that third parties get a fair and accurate assessment of your credit history.

Instructions

1

Go to annualcreditreport.com and view all three of your credit reports: TransUnion, Equifax, and Experian. You will need to cross-reference the reports to see which ones have any outdated information. If you check only one credit bureau report you might not see all the problems.

2

Verify all the credit information on each report. You may have the erroneous credit information of a family member with a similar name (individuals with names ending with Sr., Jr., or III, for example, are especially susceptible) or another person with the same name as you. There may be credit cards remaining that have actually been closed for years. But most importantly, you need to make sure that the obsolete information is truly yours. If something looks totally wrong, you might be a victim of identity theft. If that's the case, you will need to contact the credit-monitoring companies immediately.

3

Check the timeline for your credit information. Some things like bankruptcy take ten years before they can be cleared, and any request for premature removal will be denied.

4

Check the dates of the items in question, and then send a registered letter to the credit-monitoring companies requesting that they remove the obsolete information. A letter can be sent to one, two, or all three of the bureaus, depending on which reports contain the information. The letter will need to be registered and should contain any documented proof (document copies should be sent, not the originals).

5

Wait for a response from the credit-monitoring companies. They are required by law to handle the matter within 30 days. If they verify that your information is obsolete, then the items should be cleared immediately.

6

Review your credit reports a second time to make sure the obsolete information has been removed. You are allowed a free report whenever you discover inaccuracies and have requested corrections to your credit history.

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When Are Student Loans Reported on Credit?

Student loans come in many varieties and sizes. Both the federal government and private lenders issue student loans to help students meet the financial burdens of their education. These organizations can tailor a student loan to meet nearly any level of financial need. Student loans are reported to the major credit bureaus just like any other financial obligation. Before taking out a student loan, it's important to understand the impact borrowing this sum of money has on your credit.

Before Signing

Before the promissory note is signed, lenders check your credit score to determine your eligibility to receive a student loan. A single inquiry into your credit score by a potential lender reduces your FICO score up to 5 points. This means a student loan begins being reported on and impacting your credit before you see a penny.

During School

Many student loans offer a deferred payment plan while you're learning, meaning the loan payments begin after graduation. The loan appears on your credit report like any other piece of installment credit information, marked "Paid As Agreed" even though no payments have been made.

Leaving School

Many student loans offer a "grace period" after leaving school before the loan enters repayment. The terms vary between lenders, but a period of up to six months is common. Once the loan enters repayment, the balance and paid amounts are reported on your credit, lowering your debt-to-income ratio in a positive way.

Default

A defaulted student loan remains on your credit, too. Missed or skipped payments, late payments and loans that have been sent to a collections agency are all reported on your credit. These negative entries have a profound impact on your credit rating and are not removed by filing for bankruptcy, so these judgments remain with you.

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How to Get Your Average Credit Score

Your credit score is a measure of how trustworthy you are with money, gives creditors information about how reliable you were in the past about paying back debts and tells them how risky it would be to lend you money now. The information that is used to calculate your credit score is reported to three credit bureaus: Experian, Equifax and TransUnion. To find your average score, you will have to see all three reports.

Instructions

1

Go to AnnualCreditReport.com to get your credit reports online (see Resource). This is the only government-authorized website where you can find your credit score online. You can call each credit bureau and request your report by mail, but this means identity thieves could go through your discarded mail and see the personal financial information on your credit report.

2

On AnnualCreditReport.com, select the state you live in from the drop-down menu on the homepage and then select "Request Report."

3

Fill out the necessary personal information on the form, which includes your Social Security number. To keep your private data safe, make sure you do not do this on a public computer or on a wireless Internet connection.

4

Select the credit reporting bureau whose report you want to check first. AnnualCreditReport.com will then transfer you to the website for the credit bureau you choose, where you can order and view your report.

5

Pay for your credit score using a credit card or PayPal. While you are entitled to a free credit report from each bureau once a year, you have to pay for your credit score. As of 2010, it will cost you $15.95.

6

Return to AnnualCreditReport.com, select another credit bureau and repeat the same steps to get your credit scores from the other two bureaus.

7

Add up all three credit scores that you received from the three credit bureaus and divide your total by three. This will give you your credit score average for all of the agencies that collect this information.

For example, if you received a score of 680 from Experian, 692 from Equifax and 673 from TransUnion, adding them up would give you 2045. To get your average credit score, divide that by three to get 682.

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Is a Credit Score Affected If Someone Conducts a Credit Check?

A person's credit score ranges from 300 to 850 and provides lenders with an estimation of how much of a credit risk that individual is. Whether conducting a credit check affects the individual's credit score depends mostly on who initiates the credit check.

Types

Credit checks fall into two major categories. A hard pull is a credit check in response to an individual's application for credit. A soft pull is a credit check for a pre-approval, background check or one in which the individual checks his own credit report or score.

Effects

Soft pulls do not affect the individual's credit score at all. Hard pulls do affect the credit score, typically reducing it by less than 5 points. People with a short credit history or fewer accounts may see a slightly larger impact of each credit check.

Time Frame

Credit checks from the 30 days immediately before generating a credit score do not affect the score at all. In addition, multiple credit checks due to rate shopping for a mortgage, student loan or auto loan count as just one credit check. The old scoring model requires that rate shopping be done in 14 days to count as just one check and the newer model extends this period to 45 days.

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What Is the Fastest & Quickest Way to Establish Good Credit?

Good credit is the gateway to purchasing power without having to produce cash upfront. To establish good credit the quickest way, you will need to make an effort to obtain credit accounts that are valuable to your credit status. Additionally, once you start using the accounts, you will need to demonstrate your creditworthiness through responsible decisions and actions.

Applying for Credit

When you apply for credit you will want to make sure you use credit that will get reported to the major credit bureaus. Major credit cards, retail credit cards or installment loans are three types of credit that you can apply for to help build your credit. It's often easier to qualify for retail credit cards or secured credit cards than a major credit card that's unsecured. A secured credit card is good for people who have nonexistent or damaged credit that they are trying to rebuild. Obtaining and using credit with mail order companies isn't a fast way to establish credit with the major credit bureaus because the mail order company might not even report its borrowers, or they may only report to an obscure credit reporting agency.

Pay in Full

The best idea is to not charge more on your credit card than you can pay in full each month. If you pay your credit balance in full each month, you don't ever have to worry about reaching your credit limit. Thirty percent of your credit score depends on how much credit you have in relation to how much you've used. If you have an installment loan, always make sure to pay the full payment due each month. Don't skip payments or make less than the required amount.

Pay on Time

Things can happen during the month that can cause your payment to be late---a crisis, distraction or mail errors. Instead of relying on your memory and punctuality to help you make your payment on time, you can register for automatic payments via your creditor. According to information in an article posted on MSN Money by Liz Weston titled, "Raise Your Credit Score to 740," you should set up automatic payments for all your credit and loan accounts to avoid late payments, which can severely damage your credit score. Payment history is worth 30 percent of your overall credit score.

Practice Restraint

No matter what, keep the number of credit accounts or loans to a minimum that's reasonable for your financial situation. For example, if you are a college student that makes less than $1,000 per month at your part-time job, one credit card is enough. If you have a job that pays substantially more, then you could justify having more credit card accounts. Start out with no more than two credit accounts and practice responsible credit behavior for at least six months to a year before applying for a new account, according to the Kiplinger website. Applying for too much credit at one time can cause your credit rating to suffer.

When you are granted credit, you may be tempted to use it over and over until you've reached your credit limit. Resist the temptation because it will hurt your credit score. The amount of credit you use in relation to the amount of credit you have is worth 30 percent of your overall credit score, according to the website MyFICO. That means if you have a credit card with a $500 limit, you should never charge more than $150 at a time before paying the balance in full. Once you pay off the balance, you can charge $150 more. If you need to charge more than $150, make sure to pay off the balance before the closing statement each month. Then, the amount of credit you're using will show up as $0 on your credit report, which will help lenders see that you are responsible.

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Does Your Credit Rating Affect Your Car Insurance Premiums?

Credit ratings reflect a consumer's financial health at a given point in time. A credit rating, or score, is calculated on the basis of five primary factors, some of which weigh more heavily than others. Consumers with low credit ratings have difficulty qualifying for loans and credit cards, but credit ratings also affect home and car insurance premiums.

Ratings

Credit ratings are numerical indicators that potential creditors, insurance companies and some employers use to assess the risk of lending money and insuring or hiring someone. Credit ratings, or scores, range from 350 to 800. Lower credit ratings translate into higher interest charges and higher home and car insurance premiums.

Factors

The five main considerations in calculating your credit rating are your payment history (35 percent), outstanding debt (30 percent), credit history (15 percent), credit types (10 percent) and new credit (10 percent). Of these, potential lenders are most concerned with your payment history. Insurance companies pay attention to your credit history in determining your insurance premiums.

Practice

All commercial lending institutions review your credit rating along with your loan application. The CBSnews website reports that 90 percent of insurance companies use your credit history and credit rating to determine if you are an insurance risk. Even if you have never had an accident, a poor credit score can result in higher insurance premiums.

Reasoning

Although it seems reasonable that potential creditors would be concerned with your payment history and credit rating, it may be harder to understand why potential insurers would also be concerned with your rating. According to CBSnews, a representative of the National Association of Independent Insurers explained that people who manage their personal finances responsibly will also be more responsible in maintaining their home and when behind the wheel of a car.

Legislation

According to MSNBC, California, Massachusetts and Hawaii ban the use of credit ratings to determine car insurance premiums. Maryland bans the use for homeowner's premiums. During 2009, 16 states considered bills to ban the use of credit ratings as a consideration for insurance premiums. In 2010, the Michigan Supreme Court ruled that credit ratings can be used to calculate insurance premiums. The issue of insurance-scoring is ongoing. Insurance companies are fighting bans whenever legislative bills are proposed, but consumer-driven advocates are not backing down.

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Will a Settlement Hurt My Credit?

If you have a debt settlement on your credit record, it may take your credit score awhile to recover. For several reasons your credit score will suffer as a result of settling a debt (or multiple debts) with your creditors. You should develop a solid recovery plan to repair your credit.

Stop Payments

Creditors typically will not consider negotiating a debt settlement until you are about six months behind on your bill payments. They have no reason to settle with someone who is making regular payments. If you fall behind on your payments, your credit score will suffer, because your payment history accounts for 35 percent of your FICO credit score. So before the settlement, your score has already been damaged.

Settling

When you settle your debt, a note is attached to your report that indicates you settled your debt for less than the original balance. It may be indicated in several ways -- such as "settled" or "settled for less than full balance" -- but the meaning is still the same: You did not pay off your entire debt. Having debt forgiven is a negative item on your report, thus reducing your credit score. If you can persuade your creditor to report your settlement as "paid," you may see an increase in your credit score. Creditors may not be willing to report a settlement this way, however.

Road to Repair

After you have settled your debt, use all possible measures to build your credit score back up to a respectable level. Do not miss payments and reduce your debt-to-credit ratio -- the amount of debt you carry relative to your credit limit. Achieving a debt-to-credit ratio of 30 percent or less should be your goal, according to MSN Money. Payment history and the amount of debt you owe combine to make up 65 percent of your credit score. Keep these two sections healthy and your score will improve.

Other Tips

To further ensure that your score is healthy, request a copy of your credit report from the three major credit reporting agencies -- Experian, TransUnion and Equifax. You can obtain a free copy of your credit report from each agency once each year through AnnualCreditReport.com. Review your report to ensure there are no errors. Any mistakes can hurt your score. If you detect an error, file a dispute with the credit reporting agency by mail or online through the credit agency's website. The credit agency is required to investigate the claim.

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Does Closing a Credit Card Decrease Your Credit Score?

A FICO credit score contains five key variables: the amount of debt you owe, payment history, types of credit used, length of credit history and the amount of new credit applied for recently. The score ranges from 300 to 850. Closing a credit card can impact certain variables of the score and has the potential to decrease it.

Scores

Thirty percent of the score reflects the amount of debt you have. This percentage considers your credit utilization ratio as part of the calculation. According to FICO, this ratio measures how much available credit you currently have versus how much of that available credit you're using. The more credit you use, the higher the ratio. The less credit you use, the lower the ratio. A lower ratio means less of your available credit is being used and results in a higher FICO score.

Significance

An open credit card has a credit limit associated with it. This credit limit is factored into the available credit portion of your FICO score. When you close a credit card, you decrease the amount of available credit listed on your credit report. The reduction in available credit can lower your score. Your score is impacted even further if you still have a remaining balance on the closed card. This keeps the debt you owe at the same level but reduces the available credit. It will increase your credit utilization ratio and this will negatively impact your credit score.

Considerations

Closing a card can affect your credit score in another way as well. Fifteen percent of your score measures the average length of all of your credit accounts. The longer the history, the better it is for your score. Negative card accounts will report for up to seven years. Card issuers can report closed, positive accounts for up to 10 years but they're not required to. Creditors often purge their reporting rolls of closed credit card accounts. Once the card stops appearing on your credit report, it will reduce the length of your credit history and decrease your score, especially if the card you close is the oldest card that you have.

Alternative

Consider keeping the card open but not using it, especially if your goal is to increase or maintain your credit score. The open and unused credit line will work to keep your available credit high, which helps your FICO score. The card will also continue to contribute to the length of your credit history. There may be other reasons you have for closing the card. If your reason is to improve your credit score, however, FICO recommends against it.

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How Much Does Charging More Than 1/3 of Your Credit Limit Hurt Your Score?

The FICO scoring model counts the percentage of the credit limit you use -- known as credit utilization -- in its calculation of your credit score. A lower credit utilization ratio improves your credit score, although it is difficult to determine how much a particular credit utilization percentage affects your score, because many other factors come into play.

Identification

There is considerable debate about what a suitable credit utilization percentage is. The Credit Scoring website references a number of sources on the subject, with some sources suggesting that your credit utilization be less than one-third of the credit limit, while others claim 50 percent or 75 percent is sufficient. The credit scoring method of the credit bureaus remains secret, so financial experts can only approximate how credit utilization affects scores based on data they have seen. The Credit Karma website reports credit card utilization should never exceed 35 percent and produces charts on the effects of utilization ratios on credit scores based on a study it performed.

What Is Known

Maxing out a card -- that is, using all the available credit -- almost always lowers a score, sometimes up to 45 points, according to Bankrate. However, a zero percent utilization can hurt a score too, because if you do not use any credit, the credit bureaus don't have enough information to rate you. In general, less credit card debt raises a credit score.

Other Factors

Credit card utilization ratio falls under the "amounts owed" category in the credit score calculation, and "amounts owed" are worth about 30 percent of the FICO score. But credit card utilization is not the only aspect of the "amounts owed" category. Other parts include your total debt burden, number of accounts with an existing balance and the proportion of debt left on any installment loan accounts.

Tip

Charging more than 33 percent of your credit limit may put you in the danger zone, so it usually is worthwhile to pay off as much as possible. You do not need to carry a balance to keep a credit card account active, and the interest rate on credit cards often exceeds that of other types of credit. You could try consolidating your credit card debt into an account that has a lower rate, such as a home equity line of credit, although that may not lower your overall credit utilization ratio.

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Ways to Improve Your Credit in One Year

The FICO credit score is the most widely used credit score in the United States. The score measures how well you have managed your credit in the past and predicts how likely you are to default on loans in the future. Creditors look at your credit score when deciding whether to approve you for a loan and how much interest to charge. If you plan to take out a significant loan in the near future, such as a car loan or mortgage, improving your credit score can save you money on the loan.

Pay as Agreed

The single most heavily weighted factor in the FICO credit scoring algorithm is your payment history. Within this category, recent payments count more than payments further in the past, so by paying all of your bills on time over the year you can improve your credit score. Do not let your accounts go into collections. Collections occur when you have not paid your bills for a few months and the creditor turns the account over to a collections agency. If you let your creditors know that you are having a hard time with your bills, they may be willing to work with you to help you make minimum payments. However, if you wait until you've missed several payments, they usually cannot help you.

Check Your Report

The Fair Credit Reporting Act requires that each of the three credit bureaus--Experian, Equifax and TransUnion--provide you with a credit report once every 12 months, upon your request. When you request your own credit report, your credit score is not affected and you can check to make sure that all of the information on the report is accurate. If you find errors, you should write to both the credit bureau and the creditor reporting the information, explaining your dispute and enclosing copies (not originals) of any proof you have to support your claim. Credit reports are not flawless, and having a few incorrect pieces of information--such as a lower credit limit, late payments or even an account that does not belong to you--can lower your credit score. Credit bureaus must investigate your claims within 30 days. The sooner the errors are corrected on your report, the sooner your credit score will improve.

Limit Applications

Each time you apply for new credit, the creditor will pull your credit score and this inquiry will be noted on your score. Each of these inquires decreases your credit score. If you have a limited credit history, or have a large amount of inquiries, the negative impact on your credit score will be more severe. If you are trying to improve your credit score in one year, do not apply for any new credit unless absolutely necessary.

Spread Your Spending

Over the course of the year, focus on getting your debt-to-credit ratio below 35 percent on each of your credit cards. Having your overall debt-to-credit ratio below 35 percent is good, but making sure each card is below that limit is even better for your credit score. For example, if you have five cards with a $2,000 credit limit on each, and you had $1,800 on one card and no balance on the others, your total debt-to-credit ratio would be 18 percent. However, your card with the balance would have a debt-to-credit ratio of 90 percent. Spreading that $1,800 more evenly would improve your credit score.

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How Is FICO Score Different From a Credit Score?

Determining the difference between a FICO score and a credit score can be confusing, because they are often based on mutually inclusive information and sometimes may actually be the same number. Both are evaluations of a consumer's credit worthiness. However, a FICO score is derived from a consistent formula, while a credit score is determined by varying formulas, from lender to lender.

History

The acronym FICO comes from Fair Isaac and Company, the company that developed the software used to calculate the resulting score on the three major credit reporting bureaus, Equifax, TransUnion and Experian. Fair Isaac and Company was founded in 1956 and merged with HNC Software in 2002.

Function

Credit scores are used to determine whether a lender will grant credit, issue a credit card or offer a loan. The score is even used to determine what interest rate the credit will be granted at. Some lenders will use the FICO score alone, while others will use the FICO score in a combination with other information about the consumer to establish their own credit scoring system.

Variations

The higher a FICO score, the stronger the credit worthiness. However, credit scores determined without the FICO formula can be higher than the FICO score, but indicate weaker credit worthiness. These formulas are employed by the credit bureaus as well as potential lenders. Even when the FICO formula is applied across the three major credit bureaus, the score may vary, because each reporting bureau may have different information.

Changes

A FICO score can vary from month to month and even from week to week as the information on the credit report changes. For example, if you pay a credit card late, the late payment can show up and change your FICO score in one day. Conversely, if you bring a late payment history to current status, your FICO score will increase. These same actions can also impact your credit score.

Elements

Some of the information used to determine the FICO score includes the amount of credit you have, the amount of credit you use, how you pay your creditors, how long you have actually had credit and the types of credit that you have. Credit scores may also include how many times potential creditors look at your credit report, how long you have been at your current job and the number of times you have gone over your credit limit.

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Why Is it Important to Raise Your Credit Score?

The sub-prime mortgage crisis caused lenders to tighten their credit criteria. A credit score that once had lenders beating a path to your door and offering their keenest rates may no longer have the same effect. If you want to obtain low interest rates and the most competitive prices across a range of essential services, you may need to raise your credit score.

Lenders

Whether you are applying for a mortgage, a new credit card or an auto loan, your lender will check your credit score. Lenders also check scores when reviewing interest rates on existing accounts. Scores from FICO, the major U.S. credit scoring developer, range between 300 and 850; the higher your score, the lower the risk you pose to lenders. Experts at Bankrate suggest that, while a score of more than 700 once guaranteed you the keenest rates, mortgage lenders now reserve their best deals for customers with scores of 740 or more. Although individual lenders use different score triggers when deciding whether to grant credit and at what rate, in September 2010 MSN Money recommended its readers aim for a score of at least 740.

Other Score Users

Insurance providers will pull your credit score to assess the level of risk you pose. The cheapest premiums will be reserved for those with the highest scores. Cell phone companies will check your score before setting up a contract, and your score may also influence the terms of your utility contracts, including deposit requirements and price plans. Landlords will pull your credit score to assess whether you are likely to pay your rent on time; a low score may result in higher rent, a request for a larger security deposit or insistence on a co-signature. According to MSN Money, 35 percent of employers ask to see the credit scores of job applicants, using the score as a measure of responsibility.

Costs and Savings

Experts estimate that an individual with a score of 650 will pay $60 per month more interest on an $8,000 credit card balance than someone with a score of 750. Similarly, a borrower with a 650 score will pay $5,400 more on a $25,000 auto loan than those with scores of 750 and above. Add the likely cost differentials of mortgage borrowing, rent, insurance and utilities, and it is apparent that your credit score is more than a three-digit number; it has a serious influence on your financial prosperity.

Considerations

Discover your current score before you decide what, if any, improvements you need to make. If you buy a copy of your FICO score, you will also receive details of any factors that may be dragging it down. Work on addressing those issues and use the free score estimator on the myFICO website to see if there is anything else you can change to improve your score (see Resources). Be sure to order your free annual credit reports from AnnualCreditReport.com and fix any errors that may be affecting your score.

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How to Improve a Credit Score by 100 Points

Banks and other institutions are becoming more conservative with lending money, so a hit to your credit score could stop you from getting approved for a car or house loan and may cause your annual percentage rate to skyrocket. Credit repair is a long process, but it is possible with consistent effort. With perseverance, good financial planning and a little luck, you can raise your score by 100 points.

Instructions

1

Pay your bills on time. This requires patience, consistency and often sacrifice. However, paying your bills on time is the most important factor for your credit, determining 35 percent of your credit score. In fact, just one payment more than 60 days late can lower your credit score by 75 points.

2

Call your creditor if you are late with a payment. You can raise your score immediately by 20 points by explaining the situation and sending in the full amount due. If you continue to pay all your bills on time for the next six months, your credit score will rebound another 30 points.

3

Keep a low credit-card balance and, if you can, reduce it. Your credit-used-to-available-credit ratio makes up about 30 percent of your score. Statistics say that people who use more of their credit most likely have financial trouble, so using much of your available credit lowers your score. If you run up large balances on your cards or max them out, your score could drop as much as 80 to 100 points. However, if you can dig yourself out of that hole and clear most of the debt from the cards, your credit score can go up by about 80 points.

4

Check your credit report for errors. A 2004 study by the U.S. Public Interest Research Group reported that 79 percent of credit reports contained errors, such as listing an account as open after the person had closed it. If you find an error on your credit report, send a dispute letter to the credit bureau that issued the report and try to get the mistake fixed. Fixing mistakes on your credit report can often lead to a boost in your credit score.

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Does Opting Out of Changing Credit Terms Hurt Your Credit Rating?

The Credit Card Accountability Responsibility and Disclosure (CARD) Act of 2009 put heavy restrictions on the entire credit card industry, such as requiring credit card companies to allow people to opt out of changes to the terms of their account. Opting out almost always entails closing the account. While opting out may help you to control your finances or get you out a higher interest rate, you can probably expect your credit score to drop.

Identification

Closing a credit account makes it appear as though you need more of your available credit. The FICO credit scoring model factors in how much debt you use compared to the total limit of all your available cards -- this is called credit utilization. If, for example, you have $3,000 in debt and a limit of $10,000, you have a credit utilization of 30 percent. Close a card with a $1,000 limit and your utilization goes up to 33 percent.

Considerations

If the credit card you close has no balance and a low limit, the temporary damage to your score will be minimal. What you should watch out for is a card with a high balance and a minimum payment you cannot make. Once you close a card, the bank will expect you to make payments under the existing terms. If you miss payments, the bank can still report the delinquency to the credit rating agencies. Missing payments or having the account go into delinquency will hurt your credit score.

Credit Mix

Ten percent of a credit score comes from how many different types of accounts you hold. In theory, managing several kinds of loans at once gives you a more expansive experience with payment plans than just a single type of credit. If you already have another credit card, closing one has a negligible affect on your credit mix.

Misconception

Closing a credit card account does not eliminate the history -- worth 15 percent of your FICO score -- of it from your credit report; you will just stop accruing any new information for the account. Also, opting out does not always mean you have to close the account. Sometimes, the lender will try to raise rates in return for better rewards for each dollar you spend if you accept new terms. For example, the lender could offer to raise your cash-back reward to 2 percent on all purchases if you agree to a rate hike to 20 percent on your balance. If you choose to opt out of that offer, the lender could just keep your current terms and conditions.

Tip

Opting out of cards work best when you already have a FICO score above 720 and you do not expect to need a new line of credit for the foreseeable future. Instead of an opt-out, however, you could transfer your balance to a card with a lower rate or one with a zero percent teaser rate and leave the old account open, but dormant.

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