5 Facts about
Credit Scoring
Are you thinking of buying a house or a new car? If
you’re like most people, you’ll probably
have to secure a bank loan. When it comes to money lending,
most financial institutions strive to live by maxim
of ‘only good credit need apply.’ Yes, there
are lending institutions that will lend to individuals
or businesses with very low credit scores (known as
‘bad credit loans’), but these loans often
come at a high price. These types of loans frequently
come with very high interest rates and exorbitant fees
that can end up costing consumers much more than the
original purchase. Even if your credit score is not
necessarily bad, but just ‘so-so’, chances
are you’ll end up paying a lot more than a person
with very good credit.
So what exactly do lending institutions consider good
credit? Good credit is based on your credit report and
the accompanying three-digit FICO credit score.
Your FICO credit score is based on a number of factors,
including:
1) Your payment history. This includes whether you
have missed any payments, or paid late. Payment history
also involves the different types of payments (car,
house, different credit cards, etc…) you make
each month. Roughly 35% of your credit score is determined
by your payment history. A person with good credit probably
has a consistent record of paying on time each month
over a long period of time, with little or no missed
payments.
2) The amount you owe on all your different accounts.
Do you have dozens of accounts carrying high balances?
Are most of your credit card accounts maxed out? Or
can most of your debt be traced to one or two accounts,
such as your mortgage and car payments? Good credit
is hard to attain if you carry balances on many different
accounts. A person with good credit probably only carries
balances on one or two accounts.
3) The length of your credit history. This refers to
whether you have established sufficient history to provide
an accurate portrait of how you manage your finances.
Lending institutions want to know whether you have a
history of paying on time. Keep in mind that even if
you have managed your credit perfectly, if your account
is only a year old, it probably won’t raise your
credit score immediately. Keep it up for a few years,
however, and watch your credit score soar.
4) Types of credit. Another factor used in calculating
your credit score involves the types of credit you use.
Different kinds of credit include credit cards, mortgages,
and installment loans such as car and student loan payments.
If the type of credit you most commonly use weighs heavily
on credit cards and other high-interest credit sources,
your credit score will probably suffer.
5) New or recent credit history. The last factor used
to calculate your credit score has to do with your recent
credit history. This includes any new credit accounts
you may have opened, whether you’ve made requests
for new credit, and how you’ve recently managed
all of your credit. If you decide to open several new
accounts at once, be warned that this may hurt your
credit score. A person with good credit most likely
does not open new accounts frequently, but rather has
a long history with a few accounts that are in good
standing.
Now that you have an idea of what good credit looks
like, how can you improve your chances of getting a
loan if your credit is less than stellar? First, obtain
a copy of your credit report. Your report is available
from any of the three major credit reporting bureaus—Experian,
Equifax, and TransUnion. By law, you can obtain a free
copy of your credit report once a year, but additional
copies will cost you approximately $13. Review your
credit report carefully and contact the credit bureau
if you spot any errors or omissions (be prepared to
provide documentation).
Remember that so much of your credit score depends
on your payment history. The importance of paying your
bills on time, every month, cannot be stressed enough.
Many banks offer you the option of scheduling automatic
payments each month. Make use of these, if your financial
situation allows. Also, don’t open new credit
accounts if you don’t intend to use them, and
don’t open and close accounts frequently. Instead,
focus on using responsibly the accounts you already
have. This alone will raise your credit score, and make
you much more likely to get best loans from lending
institutions.
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