What is a Credit Score?

I keep seeing all of these ads for free credit reports. What is a credit score?
Credit information is collected by three credit reporting agencies: Equifax, Experian, and Trans Union. From the information collected by these three reporting agencies, a score is generated, the purpose of which is to determine the likelihood that you as a borrower will repay a debt.

What affects your Credit Score and How Much?
1. Payment History (35%)
What is your history of paying the credit accounts that you have? That is one of the first things that a lender will want to know. If others have trusted you with credit in the past, did you pay them back? Your credit history will reflect this for all types of accounts (revolving, installment, retail store accounts, car loans, mortgage loans, and finance company accounts).
Delinquencies occur when your account is not paid on time. Always make sure that you make at least the minimum monthly payment on your account. Late payments are recorded in 30 day increments. If your payment is due on the 20th of the month, it should not be recorded delinquent before 30 days have passed after the due date. A recent 30 day late on your account will affect your credit more than a 60-90 day late from 5 years ago.

Bankruptcies, tax liens, child support, judgments, and collections can stay on your credit for 7-10 years. Deal with these as they occur and work diligently to make sure that the information the credit agencies have is accurate.
Once these types of derogatory credit have occurred, it is even more important to work to re-establish your credit. Many people stop borrowing money after a bankruptcy for fear that they will not be able to get a loan. Work to re-establish your credit early. Open secured credit card accounts through your bank or credit union. Take out small loans and repay them quickly so that this information is reported on your credit.

2. Amounts Owed (30%)
The total amount owed on all of your accounts can be a factor in your score, but more specifically the amount owed on revolving accounts relative to the account limit. Balances on credit card accounts should be less than 50% of the credit limit for each account. Accounts that show more than a 50% balance can reduce your credit score; worse if the balance is above 75% of the credit limit.

3. Length of Credit History (15%)
How long have your accounts been open and how long since you used certain accounts? Installment loans should be opened and paid off. Paying them off early reduces your total debt, but does not necessarily improve your credit. Credit cards should be used every 3-4 months; this keeps them reporting accurate information and current credit information. Credit Scores look at the age of your oldest account and also the average age of all of your accounts. Closing long established accounts can lower your credit score. Leave your accounts open unless you are having an issue with a particular creditor.

4. New Credit (10%)
Are you taking on too much to handle? Credit Scores gauge the amount and types of new credit that you have and also look at credit inquiries. Accounts with less than a 12 month history can have a derogatory effect on your credit. Individuals, who roll balances from established credit cards to new accounts continually, can lower their credit scores by lowering the average age of their accounts and by not showing at least a 12 month history on existing accounts.

5. Types of Credit (10%)
You credit should have a mix of different types of credit. Installment loans (cars, boats, etc.), revolving accounts (Visa, MasterCard, Discover, etc.), mortgages, store accounts (Sears, Target, etc.) all factor in to your total score. If you have a mix of these types of accounts, with a clean payment history, that shows a good use of credit.

How to contact the credit bureaus to dispute information on your credit report:
Disputing an account can actually keep you from closing on a loan (at least with mortgages it can). People ask why, I don’t owe them anything? The lender doesn’t know what the outcome of the dispute will be. It could be that you owe more and they establish $200 to $300 per month as a payment. It could become a judgment that would be placed against your home. Disputes represent an unknown result. Be diligent when filing a dispute to resolve it quickly and make sure it gets report correctly to the three main bureaus.

Equifax: (800) 685-1111, www.equifax.com
Experian: (888) 397-3742, www.experian.com
TransUnion: (800) 888-4213, www.transunion.com

Remember that they report accurate information. Just because you say a debt is paid, doesn’t mean they will remove it from your credit file. It is important to report life events to the credit bureaus to make sure that information is reported accurately. Bankruptcies, divorces, child support, and tax liens often create situations where mistaken information is reported to the credit agencies. When you go through a bankruptcy, make sure that all of the accounts included were listed correctly on your credit. Tax liens almost always get reported delinquent, but rarely get changed to show them paid. This is your credit; make sure you monitor it yourself.

This blog is for informational purposes and is the opinion of the writer. In financial matters always solicit professional advice and legal counsel if necessary.