If you haven't checked your credit report lately, this may be the time. Wrong or old information on your report can affect your credit score – and not in a good way.
Your credit score helps lenders determine
your credit-worthiness and can impact the interest rate you pay on loans, or
even whether you can obtain a loan at all. The score reflects the information
on your credit record.
Under a recent agreement, credit-reporting
agencies are required to make changes to policies for handling errors,
disputes, and unpaid medical bills. The changes will take effect over the next
three years.
You're entitled to receive a free credit
report every twelve months from the major reporting agencies. Request a copy
now so you can begin the process of clearing up discrepancies and perhaps
improving your credit score.
How
credit scores work
If you're applying for a car loan, a home
mortgage, or a credit card to finance your next vacation, banks and other
institutions will likely base their lending decision, at least in part, on your
credit score. The higher the score (other things being equal), the more money
lenders will offer and the lower the interest rate they'll charge.
Credit scores are a relatively new
invention. As credit cards became popular in the 1960s, card issuers needed a
way to determine whether an applicant was likely to pay his or her bill on
time. Although lenders used various means to assess that risk, their methods
tended to be inconsistent and sometimes inaccurate. Around the same time, Congress
started cracking down on discriminatory lending practices by passing several
pieces of legislation that reined in lenders and collection agents.
Fair Isaac and Company developed a risk-scoring
model in the 1980s. This model was widely adopted by credit issuers and banks
throughout the United States and the FICO score was born. That score, which
ranges from 300 to 800, is based on five factors that are considered good
predictors of risk.
* Payment history (35%). This factor is
given the greatest weight. Lenders want to know how many bills you've paid late
and how many were sent to collection. The more recent the problems, the greater
the negative impact on your score.
* Outstanding debt (30%). Rule of thumb:
Keep your credit card balances at 25% or less of their limits.
* Length of time you've had credit (15%).
In general, a longer credit history will generate a higher overall score.
* New credit (10%). Opening several new
accounts tends to impact your score negatively in the short term.
* Types of credit (10%). Having experience
with several types of credit – revolving credit, installment loans, mortgages –
can push your score upward.
The
FICO score isn't the only score used by lenders, nor is it the only factor they
consider. In fact, some lenders may use a different scoring model altogether.
Nevertheless, by keeping a watchful eye on the above five factors, you can
certainly increase your odds of obtaining credit at reasonable interest rates.
What's the best way to monitor your credit? Examine your credit report
regularly and quickly resolve any inaccuracies.
