Your Credit Score Determines the Availability of Credit...and the Cost

We apply for credit for many reasons -- maybe it's to buy a new car, house, computer, or get a student loan. Often when applying for a new job, the prospective employer will obtain and review your credit report. Did you know, however, that there is a special number that can determine whether you can do these things, or at least how much it will cost you? It may also determine if you'll get that job or big promotion. Your credit score is a three-digit number that can do just that. Moreover, insurance companies often use credit scores to determine Homeowners' and Auto insurance premiums. In Texas, before public outcry stopped the practice, a utility company suggested using credit score to determine electricity charges and rates!

A credit bureau gathers data from a multitude of sources: finance companies, mortgage holders, department stores, credit card companies, court records and the like. Until about 25 or 30 years ago, this collection of information was reported to the prospective lender without editorial comment. It was then up to the individual lender to make the determination if a loan was to be granted and, if so, the interest rate commensurate with the risk of non-payment.

The result was a very subjective determination that depended on the evaluation of the raw date by individual loan officers

A credit score is a number that is calculated based on your credit history to give lenders a simpler "lend/don't lend" answer for people who are applying for credit or loans. This number helps the lender identify the level of risk they may be taking if they lend to someone. While the same end result can come through reviewing the actual credit report (which lenders usually do), the credit score is quicker and less subjective. The system awards points based on information in the credit report, and the resulting score is compared to that of other consumers with similar profiles. With this information, lenders can predict how likely someone is to repay a loan and make payments on time. It's the credit score that makes it possible to get instant credit at places like electronics stores and department stores.

There are various methods and schemes for determining one's credit score. The original methodology was developed by a company named Fair Isaac & Company and was generally known as the "FICO" score. All competing score systems are closely related to the FICO model and are statistical formulae comprised of punctuality of payments, really the payments that are more than 30 days past due, the amount of debt as a ratio between the current revolving (credit card) debt to available credit limits, the length of credit history, the types of credit used and recent applications for credit. In addition, court judgments, bankruptcies and foreclosures also are taken into effect.

Sometimes, factors other than one'/s credit score will play a part in determining the issuance of credit. For example, while employment status may not affect a FICO score, an unemployed person with no sources of income probably won't be approved for a conventional mortgage

Credit scores will range between 300 and 850, with a median of about 720-730.

Enough background; what if my score is horrible? What if I have no credit history?

Either situation will cause problems in obtaining credit. The first step is to check your credit file at the three major credit reporting agencies: Equifax, ExperIan and Trans-Union. Federal law grants everyone one free copy of his or her credit report from each credit reporting agency once every twelve months. This information is available at the only government-sanctioned credit reporting agency-operated website, annualcreditreport.com,. However, the free report does not contain a credit score, though a credit score may be purchased at the time of access.

Your credit report information may include material that does not apply to you or may be outdated or simply wrong. Erroneous information can be corrected but the effort must be made.

What if there is no credit history?

First, open a checking and savings account. Lenders look to do business with a grown-up and one indication of maturity and adulthood is a banking account.

Second, "piggyback" one someone else's account. Ask a parent, with a good credit history, to be added as an authorized person on their account. This will incorporate both credit histories; if the parent has a poor credit history, this will come back to haunt you. Having a relative co-sign for a loan will help but, again, a default will hurt everyone.

Third, obtain a credit card, just one. Make small purchases each month and pay them off, totally, as soon as the bill arrives. If you cannot get a regular credit card, ask your bank if they offer a secured card.

How to improve a rotten credit history.

First of all, ignore all of the advertisements and quick-fix schemes that promise to repair credit quickly and painlessly--all for a fee. It's not going to happen. There are ways to do the job but they take discipline and time. After all, a poor credit history was not created overnight; it will not be fixed rapidly, either.

First, check out your credit report at the three agencies. There may be patent errors, as for example, merging your history with a relative or even a stranger. There may be stale information, as, a debt or obligation more than seven years old or a bankruptcy that was concluded more than ten years before. (Be wary. Making a payment on an old stale claim or on a discharged claim from bankruptcy may restore the claim and make it current.) Advise the credit agency of its error, in writing.

Second, pay your bills on time. This is always a good practice, and it's especially critical that you make prompt payments close to the time you need a loan. That's because a late or missed payment in the last few months is likely to lower your score much more than an isolated late payment five years ago.

Third, reduce your credit card balances. A heavily weighted factor in your FICO score is how much money you owe on your credit cards relative to your total credit limit. Generally, it's good to keep your balances at or below 25 percent of your credit card limit.

Fourth, watch that ratio. Pay off debt rather than moving it around. Since the ratio of your credit card balance to your credit limit is key, closing out an account and transferring the balance simply means you increase that ratio, which is likely to lower your score. In other words, say you owe a total of $2,000 on four credit cards, each of which has a $2,000 limit. Your total credit limit is $8,000, of which your total balance ($2,000) accounts for 25 percent. If you transfer all your balances to two cards and cancel the other two, your total credit limit is reduced to $4,000, and your $2,000 balance now accounts for 50 percent of that limit. Not a good move at all!

There are many schemes out there that promise instant success. Are no magic bullets. But the effort to improve your credit score and history will pay big dividends.