Most people understand that maintaining good credit is important for
preserving overall financial health. Good credit not only leads to the
best interest rates when you apply for a mortgage or a car loan, it
also can help ensure that your car insurance rates are as low as
possible. That’s right, insurance companies have drawn a statistical
correlation between credit score and likelihood to pose a risk, and
that correlation is reflected in insurance premiums. Furthermore,
employers now routinely pull “employment reports” - which are modified
versions of the credit report that don’t actually contain the credit
score - for each candidate as part of the hiring process. Although
they don’t contain the score, employers also tend to correlate credit
history with degree of responsibility. Clearly, credit history plays
an important role in the fiscal health of most Americans.
The FICO score is the most commonly used measure by which lenders
evaluate credit-worthiness. There are a lot of theories about what
lenders require in terms of a credit score when they are evaluating an
applicant, but most seem to agree that the level required to be
considered a top-tier risk - and thus worthy of the most preferred
rates - has increased since the credit crunch descended upon us last
year. What used to require a 720-740 score may now require something
closer to a 760. Compounding this is the fact that lenders will
undoubtedly have divergent views of what constitutes quality, and they
will all use the scores a little bit differently. The message is
clear, though: credit is harder to come by than it used to be and
maintaining a strong credit score is more important than ever.
The accompanying graphic shows the breakdown of factors that affect
your FICO score, as communicated by the CEO of Fair Isaac, owner of the
FICO score. Several of these are things that consumers can do little
about in the short term, such as the length of credit history and past
payment history. You do not have much control over payment history,
except that you should get a copy of your credit report and dispute any
inaccuracies. You do have control over current payment performance,
though. In other words…always pay at least the minimum due ON TIME.
This is the single most important factor in your credit score.
The other areas are more within your control. New credit can’t be
reversed, but it can be halted, and will gradually become less new and
consequently less impactful. “Types of credit in use” refers to the
different types of loans you have outstanding and in your credit
history. They include revolving accounts such as credit cards,
personal loans and collateralized debt such as a car loan. The more
diverse your successful credit history, the better. This can be
tricky, because opening a new loan to improve in this area will hurt in
the New Credit category. This is a longer term strategic
consideration. The factor over which consumers have the most control
is the amount of credit they owe. Granted, it is not uncommon for
people to have credit card debt simply because they don’t have the cash
to pay down their balances. To the extent that they can find a way,
though, paying down balances will have a big impact on their score.
The actual algorithms used to calculate the FICO score are proprietary
and not widely known, but observers suggest limiting credit usage to a
maximum of 30% of outstanding credit availability.
To ensure your credit report accurately represents your credit history, take advantage of your free annual report at freecreditreport.com or annualcreditreport.com. To monitor your FICO score on a continuing basis, visit myFICO.