Are You Clueless About Credit Scores?

Slam-Dunking Your Credit Smarts

Quite simply, your credit score summarizes your credit risk based on a snapshot of your credit standing at a particular point in time. It isn't so much a grade, it's more like a grade point average, explains Ken Clark, a debt/credit expert, certified financial planner, and author of 'The Complete Idiot's Guide to Getting Out of Debt.' Think of it as an overall assessment of your financial responsibility, one that influences the amount of credit available to you and the conditions you may have to agree to in order to get that credit.

One major misconception, Clark says, is that people often confuse credit report with credit score. 'A credit report is an objective history of who you've been as a borrower -- it passes no judgment,' says Clark. 'The credit score is a subjective evaluation of that history.' Whether it's a credit card, car loan, or mortgage, lenders want to know your level of risk, and how likely it is they'll get paid on time.

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Learning the Lingo

The terms 'credit score,' 'credit rating,' and 'FICO score' are often used interchangeably, explains financial expert Ethan Ewing, president of Bills.com in San Mateo, Calif. 'This is basically correct. FICO simply refers to Fair Isaac Corporation, the company that originally developed a 'score' method of rating consumers' credit histories.'

Today, the three major reporting agencies (Experian, Equifax, and TransUnion) each report their own credit scores. There's the Plus Score, calculated by Experian; the Empirica Score, offered through TransUnion; and Equifax's Beacon Score. And though lenders use different factors to rate your overall credit worthiness, says Ewing, 'it basically comes down to whether you pay -- and pay on time -- and whether creditors have reason to believe you might be overextending yourself.' The more responsible you are with credit, the higher your score will be.

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Factoring the Formula

While you won't be quizzed on this later, you can earn some real-life 'extra credit' (and lower payments) by studying the factors that drive your credit score. Doug deBruyn, a Seattle-area loan originator and certified mortgage planning specialist with VanDyk Mortgage, teaches a credit-scoring class for realtors and consumers, and shares his smarts to help you pass your next nerve-wracking credit test with flying colors. Sorry, there's no 'cramming' come loan-time.

Click through the next slides to brush up on the five key components that factor into your credit score.

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1. Payment History = 35%

Are you paying your bills as agreed? The most recent six months have the greatest impact on your score. The highest weight is placed on the highest payment. Usually, this is your mortgage, next would be a car payment, followed by student loan or credit card payments. Bankruptcies, judgments, liens, and collections/charge-offs will negatively impact your score, as will late payments. FYI: The severity of the delinquency is determined by the amount, how much time has passed, and the number of times you were late on an account. It could be 30, 60, or 90 days late.

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2. Balances Carried = 30%

This is the actual dollar amounts you owe on various accounts in relation to how much credit you have available. You want this ratio as low as possible. Keep in mind, mortgages and installment loans are not factored into this as much because they are not really a credit line. FYI: If you're thinking of applying for a home loan, don't pay off collections or judgments prior to qualifying. By paying off the collection, you are, in effect, starting the collection process all over again; accordingly, your score will take a big hit. Pay off the collection at closing. Once you have the loan, you can handle a few months of a lower score.

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3. Credit History = 15%

How long have you been credit worthy? If you have a long history of making payments as agreed, it will help your credit score. But this can also hurt older people. By closing old accounts, you are removing all those years of payment history from the credit-scoring model, which is why experts urge you keep accounts you've managed efficiently open. FYI: One thing lenders had done in the past with younger borrowers is to have the parents add the child as an 'authorized user' on to a credit card account they have had for 20 years. This immediately upped the credit score of the child because he/she had 'inherited' a long credit history. However, within the past year, credit bureaus began ignoring any 'authorized user' accounts when figuring out a borrower's credit score.

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4. Mix of Accounts = 10%

Ideally, the credit bureaus like to see a mortgage, an auto loan, and three to five credit cards. For a borrower, if you have a Home Equity Line of Credit (HELOC), it will be treated as a revolving account unless it is greater than $40,000. FYI: If it is greater than $40,000, it will be considered a mortgage.

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5. Inquiries = 10%

Each inquiry will take points off of your score. Multiple inquiries for a mortgage within 45 days will only count as one inquiry (the fact that you're 'shopping around' is a given). Likewise, multiple inquiries for a car loan within 45 days will count as only one inquiry. FYI: Only the first 10 inquiries count each year. Inquiries for a job, insurance or utilities, an account review, a promotion (pre-approval offers in the mail), or your own personal review won't affect your credit score.

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Facing the Consequences

When it comes to mortgages, car loans, and credit cards, what you don't know can certainly hurt you. Your score is a reflection of your actions: choose the behavior, choose the consequence. According to the Gallant Group, a diversified investment and financing firm:

' 30 days late on a payment can damage your credit score by at least 50 or more points;
' 60 or 90 days late, or a 30-day late payment on multiple accounts can drop your score by 100+ points;
' Balances more than 40% of your credit limit affects your score by as much as 100 points;
' If multiple credit cards are maxed out or approaching maximum balances, your credit score will be diminished by at least 80+ points.

Every financial choice you make can affect your credit score, says Clark. If you keep your credit report healthy and cared for, says Clark, you'll have nothing to worry about come scoring time.

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More on Credit

' Steps to a Higher Credit Score

' Have Bad Credit Score? 5 Things to Kiss Goodbye

' How to Read Your Credit Report

' Quiz: What's Your Credit I.Q.?




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