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If you're like most Americans you've probably seen the commercials offering you a free credit score report just for the asking. Unfortunately, most Americans don't understand what a credit report is and why it's important to see what it says. But truth be known, your credit report is used by a number of institutions you might deal with financially, as a means of deciding whether or not to grant you credit. In your credit report potential lenders will not only see your history, they will also see your credit score.
Your credit score is generally a number between 300-850, based on what's known as the FICO (Fair Isaac Corporation) rating system. Although there are several other rating systems available, almost all the major credit reporting agencies use the FICO system. This system takes into account many different factors including:
- the size and scope of your total debt
- your payment history
- the time length of your credit history
- the amount of new credit you have
- the different types of credit you have accessed throughout your history
What the Numbers Mean
All of the different categories used to determine your credit score have a number value assigned to them. When all of those values are added up you end up with a number which is called your "credit score." As a general rule, the higher that score the more likely you are to receive favorable credit from lenders. The lower the number, the less likely you'll get favorable treatment. Creditors like to see numbers of 700 or higher which means you are in good financial health. Numbers below 600 represent a substantial risk and will most likely cause lenders to turn you away.
In addition, the higher your credit score the better interest rates you'll receive in most cases. For example, a new home buyer with a credit score of 750 is likely to get a 30-year, fixed-rate mortgage at a rate of 5% or better. Another homeowner with similar income but a credit score closer to 600 could expect an interest rate of nearly 8%. The same goes for credit cards, auto loans, revolving lines of credit, personal loans, home equity loans, and so on.
One last thing you need to know about this number is that it can be affected negatively by a large number of credit inquiries. For example, if you've been trying for a long time to secure your first credit card, to the extent that you've applied with 10 different companies over the last six months, that raises a red flag for future lenders. They see that as an indication that credit card companies are unwilling to take you on as a customer. That translates into risk for them and a lower credit score for you.
Maintaining a Good Credit Score
If you already have a good credit score of 700 or better, do your utmost to protect it - it is both rare and valuable. Having such a high credit score means you are at the top of the list of favored customers when it comes time to any type of credit. You'll get the best rates, the friendliest terms, and the most available opportunities. That said, maintaining a good credit score is something that requires diligence and self-discipline.
First and foremost is the necessity of paying all of your bills on time, without question. Nothing damages a good credit score more quickly than missing a mortgage payment or being late on a couple of credit card payments. You'd be surprised at how just a few of these things can drastically affect your overall credit score. And by the way, this also includes things like your utility bills and insurance payments. Make sure you pay all of your bills on time.
Second, space out your credit uses in order to allow sufficient time between different lines of credit. In other words, even if you pay all of your bills on time getting too much credit in too short a span could give lenders the impression that you are in financial trouble. You may still be able to get new credit in such a case but you're more likely to incur higher interest rates as well. By spreading out your credit you demonstrate to lenders that you are more fiscally disciplined and less likely to abuse your credit.
Third, be careful about unsecured credit like credit cards and revolving department store accounts. Whether we like it or not, this type of credit is almost always thought of in terms of consumer spending on consumable goods. If the vast majority of your credit history is dominated by unsecured credit that tells lenders that you are consumer-oriented in your spending. They may be less inclined to float you a long-term loan on a house or car if they believe you are too happy with your credit cards.
Finally, one insider trick that works really well in maintaining a good credit score is to secure a single credit card with a low interest rate that you'll use for all of your daily purchases; things like gasoline, groceries, etc. Though using credit for daily purchases is generally frowned on by credit experts, if you do this correctly it is a great tool. Here's how it works:
You set aside the cash you would normally spend on everyday purchases in a savings account. Use your credit card for the entire month for those purchases, and those purchases only. When the bill comes due, usually 10 to 15 days after the monthly cycle has ended, you pay it off entirely with the cash you set aside in your savings account. After several months of this you will have done wonders for your credit score. Just be careful not to use this credit card for any other purchases, under any circumstances; if you don't have the discipline to do so then abandon the idea altogether.
Rebuilding a Poor Credit Score
Every now and again people have financial difficulties which cause them to take a hit on their credit score. If this has happened to you, all is not lost. There are things you can do to improve your credit score in a very reasonable amount of time. Suffice it to say, rebuilding a damaged credit score does require some self-discipline and creative thinking. We'll give you a few suggestions. Here are things you can do to get the process started.
First, if credit cards were a primary factor in your current financial troubles then either destroy them and close your accounts, or give them to someone you trust for safekeeping while you repair your credit. You need to do this because credit cards are too easy to abuse, especially when you're having financial troubles. Without credit cards in your purse or wallet you'll have to exercise financial discipline in order to make sure you have cash for all of your regular bills.
After you get rid of your credit cards, contact any lenders with whom you are behind on payments and explain your situation to them. As long as you are honest and upfront, most will be willing to work with you on an acceptable payment plan. Take advantage of such payment plans and be faithful to them. Nothing says you deserve a higher credit score than working out your financial difficulties and getting all your bills paid on time.
As you're working through these things you can then look for other ways to reestablish good credit that don't require credit cards for traditional lending institutions. One good example is the wholesale used car lot that self finances purchases. This might be the place to go when it's time to replace your vehicle, especially if you don't think you qualify for an auto loan anyway. As long as you're faithful to your weekly or bi-weekly payments, paying off that car will do wonders for your credit score.
Building a Credit from Scratch
For young people, having a high credit score is nearly impossible because they don't have enough time invested in it. To build a credit score from scratch you need to start with things like secured credit cards and loans that are easier to get, like car loans. Banks are more likely to lend you money for an automobile than a house because the automobile is collateral that can be more easily seized and sold in case you default. With a house things are not so easy.
With a secured credit card, you deposit a certain amount of money with the bank which then becomes your credit limit. That money remains in a savings account as long as you pay your credit card bills on time. The bank only touches that money if you are late on a payment. After a year or so with a secured credit card a bank will usually offer you an unsecured card and return your deposit to you.
Some Final Thoughts on Your Credit Score
Your credit score is more important than you know. Not only is it one of the primary tools lenders use in deciding whether or not to loan you money, but it's also a tool used by employers, insurance companies, and other institutions. For example, did you know that employers often check the credit histories of those looking for a job or seeking a promotion? Your credit score provides employers with a good gauge of your character and integrity. If they see you have no control over your finances they are likely to question whether or not you'll exercise any self control in the workplace.
Likewise, insurance companies factor in your credit score when determining your risk as the policy holder. An apartment complex will check your credit score when determining whether or not they should lease to you. There are so many possibilities that listing them all here would be entirely pointless. Suffice it to say that protecting your credit score is one of the most important things you can do for your financial well-being. Never forget that to the rest of the world, you're only as good financially as your credit score.