Credit is a necessary evil to many people. If you follow a few common-sense truths about credit, it’s a great tool to have around. Unless you have a money tree, you will need credit.
The term “credit” is commonly interchanged with a generic use of “FICO score” or “What is my credit score?”.
WHAT IS CONSUMER CREDIT?
A simple question with several answers.
Generally, credit is a function of lending something to someone else. Or in other words, debt incurred when purchasing a good or service.
Credit helps the lender decide whether the borrower is worthy of the risk. Will the borrower be able to pay back the lender on terms set in the contract? One piece of the puzzle has evolved into the use of credit reporting and, later, the creation of credit scores.
Credit Score and Credit Report: Is it all that simple?
The three commonly used credit bureaus, sometimes called repositories are Transunion, Experian, and Equifax. Each one produces a different score. And, the reality is lenders use a variation on the score to determine a borrower’s creditworthiness.
Let’s circle back to “credit scores.” With three companies and three main scores, you can see there is room for confusion. Whenever we discuss scores about credit we mean FICO score…. this is the gold standard for all credit.
FICO stands for Fair Isaac Company. Initiated by the fair Isaac corporation, it is one of the most respected score ratings in the country as almost 90% of significant lenders use it.
The scores average from 300-850 and anything above 650 is termed as very good, but 750 and above is an excellent result.
Most home loan programs start at 620, but this gets us into another topic.
Do not be confused, abused or end up disappointed when you rely on credit scores that are not FICO driven. Many websites offer a package deal…3 reports and three sets of scores.
FICO scores are the Experian products which will most closely match those of an auto dealer, home loan officer, and other credit issuers. We will go into detail later into this topic, but don’t waste money buying multiple reports and scores to see if you experienced a change.
Yes, access your reports to make sure they accurately report your history.
No, do not buy just any set of reports. I will discuss how to “clean up” up your reports in another article.
The three credit bureaus I mentioned earlier; Equifax, Transunion, and Experian are the major reporting agencies that financial institutions access when planning to approve or deny credit.
As a credit reporting agency, they don’t work together or share information. As a result, a new window opens for inconsistent reporting.
The FICO Mystery and How to Work Within the System.
This is one of life’s great mysteries. Credit experts have been able to put this mix together based on a historical perspective. Mostly, the rates consider a lot of factors, but the benchmark is always there for anyone to look at and incorporate into what his or her rating score shows.
FICO scores are variable calculations based mainly on:
(1) Paying history – how long have you had credit on record;
(2) Types of debt you show – a home loan or an auto payment is weighed heavier than a Victoria’s Secret/Pink card;
(3) How you use your credit or do you use it at all? Do you carry zero balances or do you “over-utilize”;
(4) How much new credit have you applied for recently;
(5) Do you have any outstanding judgments against you?
The credit report contains other self-reported information that may not be a part of the scoring system. Each time you complete an application, all of that information is stored on the report.
Name, aliases, variations, address and phone, type of work. position held and, the dates of all of these will be included.
Income is not a factor in FICO calculations and is rarely reported on paper, though income is clearly a factor in any decision to lend.
Further Deep Dive – What Percentages Are Assigned By The Experts To…
(1) Payment History – 35%
What companies like FICO are interested in is how quickly you can pay back the money you borrowed, and that is why an excellent credit history takes up a whopping 35% of your credit score. It is just as important to use the debt as it is to pay on time.
If you use credit and are always paid up… no history.
If you use debt and pay late or not at all…bad history.
(2) Accounts Owed – 30%
You must have accounts to make history. If history indicates that you have used up your available credit, this could play against you. Likewise, if you open too many accounts at once could end up with a hit.
(3) Length Of Credit History – 15%
The older the credit file, the more history to put all events into perspective. A negative item has less impact on someone with 30 years of history and 30 accounts.
(4) New Credit – 10%
Taking up too many credits at the same time makes you a liability and can affect your credit score. Credit is built over time and not in one sitting.
That said, time does heal negative items that have been resolved.
(5) Credit Mix – 10%
A right blend of credit types helps you build your credit score. Credit cards, retail loans, mortgage, automobile loans show you are creditworthy and attracts a good score.
How to Improve Credit Scores?
These topics are easy to dive into in separate articles which I will do it later. The first step is to order one report each directly from each of Transunion, Experian, and Equifax. In fact, you should be able to do this online and review online as well as dispute items you know to be incorrect.
If you dispute something, wait until the end of two months before you pull the report again. Do not expect all reports to mirror one another or share information.
Hey, What about Income and Credit Scores?
Other than credit, the stability of your income and your address can matter. A lender may ask you to produce proof of income. Generally, the lender is trying to gauge whether you can pay your monthly minimum debt payments on your existing income.
When monthly income exceeds monthly debt payments, you are usually in good shape. Often, however, it is our history that we need to worry about. Maybe we have a good income ratio now, but past lives left us with debt that still burdens our scores.