It’s a well-known fact that a good credit score is paramount in securing a loan, and that it directly affects the rate offered if the loan is approved.
The credit scoring system, which was developed by Fair Isaac Corp. in 1958, became prevalent in the 1980s as a way for lenders to quickly evaluate a potential borrower’s credit worthiness. Just how much credit history impacts other aspects of everyday life, however, can be overlooked.
Credit score and a person’s credit history are a financial “shadow” of sorts. For example, employers have the ability to check the credit history of potential employees. While this practice is controversial, it is also becoming more common. Employers argue that how a person handles personal finances reflects on how they handle responsibility. A prospect with less than adequate credit may be passed over in favor of a candidate with a comparable skill set and experience level, but with a more respectable credit history. A prospect with a bad credit score may be taken out of the running altogether, regardless of qualifications.
Insurance rates for homes and vehicles are also affected by credit history. While it is not the only piece of information used to determine an individual’s “insurance score” and subsequent insurance premiums, credit score is among factors considered when establishing insurance premiums.
Credit Score 101
A FICO credit score is based on statistical validation used to accurately predict financial risk over time. Scores fall between 350 and 800, and are calculated using a compilation of five categories. The categories are weighted, with payment history accounting for 35 percent; total amounts owed, 30 percent; length of credit history, 15 percent; new credit, 10 percent; and type of credit in use, 10 percent.
Because payment history is 35 percent of your credit score, late payments will significantly affect your credit score. Negative marks may remain on your credit reports for seven years. So, always make payments on time. The total amount you owe comprises the next largest portion in the credit score formula, so keep outstanding debt in control and make timely payments. Keep older accounts in good standing open, as closing them may actually lower your credit score. When looking for a new loan or credit card, rate shop within a focused time period to avoid appearing as though you are always looking for credit. Avoid opening multiple accounts you don’t intend to use; this can negatively impact credit score.
Keep in mind that you can’t improve your credit score unless you know what is on it, so get a copy of it from all three credit bureaus: Experian, Equifax and TransUnion to find out what needs attention. If you find inaccuracies on your credit report you should dispute them and have them fixed.
While many credit score tips are very clear cut, others are a bit less clear. Credit card utilization rate – total credit card balance divided by total credit card limits – indicates how credit is managed. Typically, a utilization rate of 30 percent or below is viewed as “healthy” and shows responsible use of credit. What may be surprising is that no credit utilization is problematic to a credit score because it does not help build credit. Lenders look for good payment history, as well as an active credit profile because this shows that credit is available and well-managed.
If you’ve worked hard to increase your score, you’ll want to work even harder to keep it there. Unlike Peter Pan, your shadow – in this case, your “financial shadow” – is firmly attached.
Diane Morris is marketing director at Beverly Cooperative Bank. Email: dmorris@beverlycoop.com
