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Category: Articles » Finance » Credit » Article » Article Code

Understanding Your FICO Credit Risk Score

Most people know that our credit reports have a lot of information about our borrowing history. How credit worthy we are - how likely we are to pay off our debts (on time or not) - is also looked at as an indicator of how people are likely to behave in other areas. Employers depend on credit reporting to see if we'll be good staffers. Landlords pull credit reports to see if we'll be responsible renters. Insurance companies rely on credit information when deciding what sort of an insurance risk we are. But for years there's been a piece ... read more

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Employers depend on credit reporting to see if we'll be good staffers. Landlords pull credit reports to see if we'll be responsible renters. Insurance companies rely on credit information when deciding what sort of an insurance risk we are. But for years there's been a piece of the credit report puzzle that the average consumer has been unable to see.
 
 
 
YOUR CREDIT REPORT & SCORE
 
 
 
It's called a credit risk score - and if you have a credit rating you have one. The scores range from 300 to 850, with a higher score being better than a lower one. Fair Isaac, which is the country's pre-eminent producer of credit scores, takes information from your credit report, gives different weights to different pieces of that information and how long ago those things occurred, and comes up with a number for you. Then when a lender is trying to decide whether or not to give you a mortgage, for example, or what rate of interest to charge on your loan, the score is one important factor they consider when making a decision.

HOW MANY LENDERS USE THESE SCORES?

We know that over 3/4 of home loans are decided with help from FICO risk scores. If you look at the 100 largest financial institutions in America, 70 percent use FICO scores. So credit scores are a big player in the marketplace.

HOW DO MOST PEOPLE DO?

Better than you might think, considering that bankruptcies are in the headlines so often these days. With the scale ranging from 300 to 850, the average score is about 720.

Having a score below that, you may have problems borrowing. Here in the States, 20% of people score below 620. Since that population includes about 50% of all people who default on their mortgages, lenders are very wary of extending credit to them. The next 20% of people score between 620 and 690. Scores in this range may not stop you , but buyers of mortgage pools on the secondary market require that lenders scrutinize borrowers much more closely before lending. On the high end of scoring, anything above 780 is considered elite. Only about 1 - 2% of consumers score in the 800s.

There are a few factors that make a big difference in your score - let's talk about them and how you can make changes in them to improve your score:

-Your bill-paying record (This accounts for 35 percent of your score). We all know to pay bills on time. If you always have, you've done well in this category. If you slip up here and there, it can hurt your score a fair amount. The more recent the slip up, the more it hurts your score. And, as in all of these categories, a pattern of bad behavior is worse than one mistake. A string of 30-day late payments is worse than one 60-day late. (The way credit scoring works is to compare your habits to those other individuals who have proven to act in a positive or negative way overall. But there are different groups of patterns, so a seasoned user won't be compared to a new user.)

-How much you owe now (30 percent). The scoring companies look at how much you owe relative to how much credit you have available on your credit cards. The closer you are to maxing-out your cards, the lower you'll score in this area. But owing nothing doesn't prove your ability to handle credit - owing a little bit is better. For example, being at 80 percent of your limit would be viewed as very high and a negative; 60 percent in most cases is detrimental enough. Having your balances at 20 to 30 percent of your maximum is just fine.

-How long you've handled credit (15 percent). When people are trying to get their spending under control, one of the things they do - indeed that we might advise them to do - is to make sure they don't have too many tempting cards in their wallet. But, when it comes to your credit score, you may not want to cut up that one card you've had the longest. Then the credit scoring companies lose the ability to see just how long you've been managing credit. It may be better to keep that old card even if it's at a high interest rate, use it a couple times a year and pay it off completely rather than cutting it up.

-Mix of credit (10 percent): It's good to show that you can manage different kinds of credit. So having an installment loan (on a home or a car) as well as having a revolving credit account (credit card) is a positive.

-Pursuit of new credit (10 percent): The media often exaggerate how much searching for new credit can hurt you. That's because, a few years ago, the scorer's methodology was changed to reflect the idea that it was OK - indeed smart - to be shopping around for a loan. So all of your inquiries into a mortgage over a 30-day period now count as one. That said, if you have real credit problems and you're constantly shopping around for new cards or loans, it's going to hurt your score. Moderation is key. If you're out looking for new credit every month, it's a minus. Less frequently than that, you'll probably be okay.

Now that you that you know some of the major scoring factors you may use the information to either continue your already good credit or to start to improve items on your credit report that can have a major effect on improving your scores. After you get your credit report, you may use it to open up discussions with lenders in a preliminary way. You might address a mortgage broker by saying; "This is my score. How smoothly would the mortagage process go with my score?" Then, if you need to, you can work on your score before you apply for credit. Three to six months is a reasonable time frame for being able to significantly improve your FICO scores.

If you run a Web search for "free credit score," you'll most likely come up with a number of mortgage lenders and banks who may be willing to give your score to you. In some cases, you may have to actually apply for a loan. In other cases, giving them an e-mail address and phone number (so that they can market to you later, one assumes) seems to be sufficient. So if you're willing to give up some personal information, you can get your score for no money. Or you can pay the $ 9 - $13 to the credit reporting agencies and receive your scores. (Even if you're not up for checking your score, you should check your credit report about once a year. If there are problems, you should check all three of the credit bureaus.)

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