Scoring Your Credit
Money: Save thousands of dollars by understanding and improving your FICO score
Back in high school and college, one simple number — your GPA — could make or break your future. Wasn’t it great to finally graduate, get your first job and put behind you a system that boiled down a person’s worth into one number?
Well, I have some bad news. There’s an adult version of the GPA, and it’s just as important.
It’s called your credit score, known as FICO and created by Fair Isaac Corp. The number runs between 300 and 900 and tries to gauge a consumer’s propensity to pay his or her bills. In theory, a least, the higher the score, the more creditworthy the borrower.
Your credit score is the main factor used to determine whether you get a loan and what interest rate you will pay. Borrowers who score above set FICO thresholds get lower-rate loans and special privileges; borrowers who have low scores are snickered at when their backs are turned and forced to dance for pennies. Okay, I may be exaggerating. But if you talk to someone with a very poor credit score, I’d bet they would choose dancing for pennies over what they’ve gone through buying a house or car.
Here are the relevant thresholds:
- Score higher than 700 and you not only get the best loan terms, but lenders also may make the loan without asking questions about your income and assets.
- Score 660 or better and you get the best rate from virtually all lenders, but you will have to provide documentation of your income, assets and debt.
- Score between 620 and 660 and you may get a preferred-rate loan, but lenders will look more closely at the nature of the transgressions on your credit report to determine whether to push you into the dreaded sub-prime market.
- Lenders consider anyone with a score of less than 620 to be a sub-prime borrower. Those borrowers pay at least 1 percentage point more in interest on a home loan and may have to accept unattractive loan features such as prepayment penalties.
So what’s the big deal about an extra 1 or 2 percentage points?
Take a look at this example. You buy your dream condo in hip Arlington for $200,000. But instead of getting a 6 percent interest rate, your bank charges 8 percent. Because of the higher rate, over the next 30 years, you pay nearly $100,000 more interest than if you had received the 6 percent rate.
Now, that’s a big deal.
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So what can you do to improve your credit score? Naturally, over the long run, you simply pay your bills on time, keep your credit card debt to a minimum and don’t take out huge loans that you can barely afford.
But there are also some things you can do right now to help improve your score. Here are tips to crank up your FICO score:
Check your credit report for errors.
Approximately one-quarter of all credit reports contain errors that hurt the person’s FICO, so it’s worth your time to take a look and make sure that all the information on your report is correct.
But remember to order your reports directly from one of the three major credit reporting agencies — Equifax, Experian and TransUnion — or MyFICO.com. Using Web sites that offer free or easy credit reports leads to what’s called a “hard inquiry” into your credit — essentially the FICO system thinks you’ve asked to borrow more money and a creditor is checking your credit. That can lower your score.
Pay down your credit cards.
Part of your FICO score is based on the ratio between your credit limit and the amount of credit-card balance on your cards. By paying down your credit card debt, you increase that ratio and improve your FICO score. (As an added bonus, you also reduce the nearly criminal finance charges that you pay to the credit card companies.)
Resist taking out store charge cards.
Each time you apply for a store credit card, your FICO takes a hit. In the strange world of FICO, taking out store credit cards amounts to excessive “shopping” for credit cards. Too many inquiries are frowned on by lenders, who read it as a desperate bid for credit because of financial problems.
Don’t close your old credit accounts.
Since part of your credit score is based on the length of your credit history, closing old credit accounts generally hurts your FICO score. Consumers often close their old credit card accounts when offered a new, lower-rate card. Don’t do it! Instead, call your current credit card company and ask them to match the new card’s offer. Nine times out of ten, your current credit card will give in.
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