Your Credit History, Credit Score and Why it Matters.
Credit is sometimes considered a necessary evil. Borrowing money seems to be part of our culture and it's not inherently bad- if used correctly.
Many money gurus (Dave Ramsey, Suze Orman) will tell you only to buy things using cash which sounds great and is great advice. The truth is that the majority of us will never know what it's like to buy a home with cash.
There are numerous credit scoring companies each with their own algorithms as to how they determine your score. These algorithms are not meant to be understood by the public because they tend to change frequently- and usually do not benefit you as the consumer.
The three major credit reporting agencies are Experian, Equifax and TransUnion. They are all very similar however there may be creditors that do not update or report to all three which mean there could be inconsistencies.
Before we dig in to look at the various aspects of credit, it's important to know and take to heart- YOU ARE NOT YOUR CREDIT.
Lenders, other Realtors and maybe even your parents will rate and judge you by your credit. The stories and circumstances are endless. Everyone has a history and some are cleaner than others but your worth as an individual is not determined by your score.
With that, let's take a look at the factors that impact your credit.
A credit report is a long form representation of the credit accounts of an individual. It reports and maintains credit information usually for 7-10 years depending upon the type of impact it has and consists of the following information:
1. Identifying information
Name (previous names, maiden names), address, previous address, employer, social security number and birth-date).
The name and account number of any creditor that has issued credit to you.
3. Type of account
Installment loans, auto loans, mortgage loans, credit lines.
When an account was opened or closed.
5. High credit amount
The highest credit limit granted by the creditor.
6. Current balance
The balance outstanding at the time the report was most recently updated.
7. Late payment history
Indicates a history of on-time payments or payments made 30,60 or 90+ days late.
8. Credit inquiries
This includes inquiries made prospective creditor (hard inquiry) in addition to inquires by you, an existing creditor or a marketing company (soft inquiry).
9. Public records and collections bankruptcy, repossessions, and foreclosures
Self-explanatory. These are records of public judgments, tax liens, collections, bankruptcies or foreclosures.
A credit score is a numerical representation your credit report. Scores range from 350 to 850 with the higher number being better. Since different creditors report to different credit bureaus, most lenders will compile what they call a "tri-merge" and pull all three. They will either use an average or the middle number. In general, most lenders will look at your credit score and place you in a certain category:
720 or higher: Excellent
660 - 719: Average
620 - 659: Poor
620 or lower: Bad
Your credit score is calculated based on the following:
Payment History - 35%
This is a calculation of how timely parents are made.
Capacity - 30%
The difference between what you owe and your high credit limit. A credit card limit of $5,000 with an outstanding balance of $0 would indicate a larger capacity and thus a greater positive impact on your score.
Length of Credit - 15%
How long you've had active trade-lines. The longer the accounts have been opened, the better the impact on your score.
Accumulation of Debt - 10%
How much debt you've accumulated in the past year.
Mix of Credit - 10%
How much unsecured debt versus secured debt you have.
Why does this matter?
Your credit history feeds into your credit score. Your credit score is used by lenders to determine what they call a 'risk rating' which helps them determine your risk level and your probability of repayment. A lower score would mean a higher probability of the lender collecting whereas a higher score would indicate there is smaller risk.
This matters because lenders will assign a higher interest rate to lower score borrowers. They may not even extend credit at all. Higher rates equal higher payments which only benefit one party. Can you guess who?
In the example above the difference in credit scores equates to paying an extra $106,560 over the course of a 30 year loan. $106,560! That's $106,560 for the same dollar amount and the same house. It literally pays to be up-to-date on your credit report and score.
Visit AnnualCreditReport.com to get a free copy of your credit report from all three bureaus. You are entitled to one free report, per bureau, per year. This is the ONLY site to get a free report that doesn't require a credit card or for you to purchase credit monitoring.
Check CreditKarma for your free credit score.
Double check your report! It is not uncommon for there to incorrect information on your report. Be sure to follow up and dispute any incorrect information.
What questions or myths have you heard about credit?