Until recently,
people mostly were able to spend money only if they have them. With ability to borrow
money through credit cards, mortgages, student and personal loans, people got
the clear opportunity to spend money they do not have – borrowed money, paying
certain percent for this use.
Why you Need Good Credit History?
When you lend
money yourself, you will not give it anyone who will ask for that. The
organizations, which will provide you with loan, will be even more sensitive,
choosing the reliable people and getting the adequate conditions. For those who
look more reliable, the financing conditions will be essentially better, than
for those who may become a burden over time, not able to pay back.
So, a good
credit history will benefit you in almost any major purchase that requires
financing - buying a home, getting an auto loan, or setting up a business. When
lenders review your credit history information, your credit score plays a big
role in setting your interest rates and repayment terms. If your track record
of building credit history is excellent, your efforts will save you money on
interest charges. The same rule applies to insurance coverage; a high credit
score means lower monthly premiums.
Landlords will
use your credit history to gauge how likely you are to pay your rent on time.
Phone companies and cable service providers examine your credit history to
determine if you'll be a responsible customer.
Who Defines your Credit Score?
There are many
credit reporting bureaus in the US, of which the three main ones are Experian,
Equifax and TransUnion. These bureaus maintain a credit file of every person
who has ever borrowed any kind of credit. All your credit information, bank
account information, loans, payments, etc. is contained in the credit file. On the basis of this information, a credit
score is calculated as simple numerical prediction of our creditworthiness.
Although there
are many different types of credit scores, the most important is the FICO
credit score. This is the credit score
that is used by the 3 leading credit bureaus in the country and it is also the
credit score which the majority of the lenders look at to determine your credit
worthiness.
The Fair Isaac
Corporation (FICO) first developed the formula to calculate a person’s credit
score based on their credit information. Since then, the FICO credit score has
been accepted as the most official credit score in the US. Although there are
other credit scores, none come close to the FICO score in terms of
authenticity, correctness and nationwide acceptance.
A FICO credit
score is a three digit number which can be anything between 300 and 850. A
score in excess of 760 is considered to be an excellent credit score. Scores
ranging from 700 to 759 are good, those ranging from 650 to 700 are average,
and below 650 are low credit scores. Don’t feel bad if you are on the low end
of excellent. Scores of 800 or higher are extremely rare. Even so, the median
score is around 720, meaning half of all people have scores higher than 720.
Note that the
same information, received by three competing credit bureaus, can produce
different results, since the credit score calculation algorithm is slightly
different. Each lender or credit issuer can choose whom it asks for your credit
history. If several of your applications result in credit pulls from Equifax,
your credit report and score may look different than one from TransUnion. Each
bureau also manages your details separately from the others, so if there is a
blemish on your credit report that needs to be fixed, you need to follow up
with each bureau to make sure it has accurate information.
What are the Factors Affecting Credit Score?
While Fair Isaac and all credit bureaus keep the score calculation
algorithms as top trade secrets and never reveal the exact formula, there is
the following indication disclosed of what factors influence the score and what
the weight of each of these factors is:
·
35% -
Payment History. Not
surprisingly, the biggest chunk of the score is your record of timely payments.
If you pay your bills on time, you’re likely to continue paying your bills on
time in the future as well. In brief, any late payments of 30-days late or
worse can show up here, although a 60-day late or a 90-day late delay will have
even bigger negative impact. If you just barely miss a due date and pay it off
within 30 days, it shouldn’t show up here.
·
30%
- Credit Utilization. This
refers to the trend of how much of your available credit you are using, the
value also known as utilization ratio. From the creditability perspectives, the
lower the better. Being maxed out on all your cards is obviously not a good
sign. Utilization ratio is tracked both on an overall level and on a per
card level. For example, having five different cards with a $1,000 balance
each and $10,000 credit limit each (10% ratio x 5 cards) is better than having
4 cards with no balance and one card with the $5,000 balance (50% ratio on 1
card). On the long run, having more credit cards would be a good thing as it should mean more
available credit and a lower utilization ratio.
·
15% -
Length of Credit History.
The longer your credit history is, the better. Both the age of your oldest
account and the average age of all your accounts are tracked. Continuously
opening new credit lines may thus hurt your credit score. At the same time,
having a lot of old cards can “anchor” your average account age as well. If I
already have 20 cards averaging 8 years old, adding another new credit card
won’t make that average budge hardly at all. The closed account will stay on
your credit report for 10 years.
·
10% -
Types of Credit Used. This
factor refers to the mix of different credit accounts out there – revolving
credit like credit cards, retail accounts (store cards), installment loans like
auto loans, and home mortgages. Having a greater mix is better. However, due to
the lesser weight of this factor, you should not deliberately open store cards,
take auto loans, and buy new houses with mortgage, unless you really need this
kind of the financial activities.
·
10% -
Past Credit Applications.
This low weight factor comes into play when you are working on some important
financial operation, for example, shopping for refinancing, or purchasing a new
real estate, or shopping for extra credit cards. This factor is taken in
consideration because multiple inquiries and applications in a short period of
time may represent an indication of existing or expected financial troubles.
Therefore, you should be very careful with what are called “hard” credit
inquiries. Hard credit inquiries (“pulls”) are usually from loan applications
(asking for more credit). Soft credit inquiries occur when you are just
checking your own credit score, or when other financial companies check your
credit history as identity verification or for pre-approval offers. Hard pulls
affect your credit score negatively for a temporary period of time. For
mortgage and auto loans, there are special accommodations by FICO for
“rate-shopping”; all hard inquiries within a 14 day period for mortgages or
auto loans will only count as one inquiry. In regards to apply for new credit
cards, it’s difficult to know the effect of a hard inquiry by itself, as a new
credit card account will also affect the other factors above (average age of
accounts, credit limits, and utilization ratio). For someone with a longer
credit history, a new credit card application will have little effect. For
someone with zero credit cards, it will have a larger effect. The general
consensus is that each hard pull knocks about 3-5 points off your credit score,
and the effect decreases as time passes – after 6 months the effect is reduced,
and after a year it is gone. The recording of inquiries does stay on your
report for 2 years.
What is Better: No Credit or Bad Credit?
The common sense
says that people with bad credit should have a lot more hard times getting
loans with bad credit. Bad credit tells bankers, loaners, etc. that your credit
worthiness is not good enough for them. People with no credit should have a
better chance because they have no negative reports against them.
However, the
financial specialists often claim that the common sense does not work here. They
think, a bad credit is better than no credit. Bad credit means that you were
extended and trusted at least at one point in your life. Bad credit score could
also mean that you're paid off, but the bad history of the past is still
weighing your score down. Depending on your current credit situation, you'll
probably get extended another loan or card...your rates will stink, but you'll
get one. Also, bad credit shows that the application you filled out is probably
not filled with any fraudulent information and they will have some way of being
able to get a hold of you.
NO credit may be
riskier for creditors because they have absolutely NO track record to what the
person's character is. With no credit or anything on your report, how do they
know that none of the info on the application is good or bad? Someone with no
credit is going to have the higher interest rate from the beginning.
How to Fix Bad Credit?
·
Pay all
bills on time or ahead! To help simplify the process, once you get paid, pay
all the bills that are due between then and your next paycheck. Allow time for
the mail and processing.
·
Learn
to live on your take-home income. This means if you do not have the money,
don't buy it. In other words, do not add to your existing credit balances.
·
Pay all
charged-off accounts that appear on your credit report. A paid charge-off is
much better than just a charge-off.
·
Create
a realistic plan to allocate a portion of your income to pay off large credit
card balances. A high debt-to-income ratio could be causing you to lose points
on your FICO score.
·
Give it
some time. Most creditors look at your most recent credit history (last two or
three years).
How to Fix No Credit?
·
FICO
developed the Expansion score to help new-to-credit borrowers. It looks at
information not included on a regular credit report, including utility and
rental payments, payday loans and use of a checking account. Ask your lender if
they use the Expansion score.
·
Apply
for a secured credit card. A savings account secures the card in case of
default.
·
Once
you have used your secured card for several months, apply for an unsecured
credit card. You may have the best luck with a retailer or with the same bank
from which you received the secured card.
·
Your
credit history measures all types of credit accounts, so you may want to
establish a longer-term installment loan for a car or some other large purchase
loan, such as furniture, with pay-back terms of longer than one year.
·
To
avoid problems, never borrow without knowing how and when you will be able to
pay off the balance. Also, you should establish an emergency savings cushion
for those times when life throws you an unexpected curve.
Sources and Additional Information:
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