Friday, October 20th, 2017

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The Truth about Credit Scores

I sat patiently in the mortgage broker’s office. She gave me a raised eyebrow. I was 29 years old, going through a divorce and had not been employed for the past four years. I scrambled to tell the broker I recently completed an M.B.A. This elicits a smile…until I informed her that I planned to return to teaching, eliciting another raised eyebrow. My new degree added plenty of student loan debt. This did not look good.

"One moment ma’am, I just need to pull your credit report off the printer." I silently considered the possibility that these would be the mortgage broker’s last words to me.

The mortgage broker re-entered the room a new woman. "I’ve never seen someone your age with scores so high. I could write you a $200,000 home loan today."

Though flattered, I wondered who would make the payments on that $200,000 home. I returned to my apartment excited (I can get a house!), proud (She’s never seen scores higher!), and more than a little confused. What do those three numbers actually mean?

Credit scores, pioneered more than 30 years ago by Fair Isaac Corporation, provide U.S. consumers faster and more convenient access to lending. Craig Watts of Fair Isaac refers to credit scores as an adult’s GPA. Lenders in a variety of industries use credit scores to control their risk when extending credit to consumers. Gradually more auto insurers use credit-scoring models to assign risk and set rates for new policies. A recent Society for Human Resource Management poll found employers increasingly look at applicants’ credit histories.

What makes up your credit score?

Credit scores are comprised of 22 pieces of data collected from the three major credit bureaus: Equifax, Experian, and TransUnion. Each bureau returns an individual score. Typically, the median score, not the average, will be used to determine creditworthiness. Scores can vary as much as 50 points between the bureaus due to variation in data collection dates. The five major categories used to determine credit scores are: payment history (35% of the rating), length of credit history (15%), new credit (10%), types of credit used (10%) and debt (30%). Income is not factored into credit scores.

Credit scores typically range between 300 and 850, but only 13% of consumers score above 800. Generally speaking, scores of 300-500 indicate numerous late payments, accounts in collection and other derogatory information on the credit report. A score of 620-700 shows a decent history of on-time payments, although some late payments may have occurred. Scores higher than 700 show responsible debt management.

How to improve your credit score

The key to credit scores — the great elusive mystery — is incredibly simple. Consumers should pay their bills on time every month. Remember that 35% of the credit score is comprised of payment history. Other recommendations to improve credit scores include: paying more than the minimum amount due on credit cards, maintaining two to four credit cards at a balance of approximately 0-30% of the limit (even if you plan to pay off the balance at the end of the month – remember different bureaus pull information at different times!), and establishing long-term credit history.

Equally simple are the credit "no-no’s." Delinquent accounts, or ones that have gone into collection, have extremely negative consequences. Kimberly Lankford reported that something as seemingly inconsequential as overdue library books can have a dramatic impact. According to her article "Boost Your Score," many local governments hire collections agencies to track down money owed for items such as library fines. Accounts in collection, even library fines, can lower credit scores by as much as 100 points.

Now I realize how critical it is to pay my bills on time. I am also fortunate to have only one credit card with a low balance and a long history. My discoveries regarding credit scores have lessened my curiosity and eased my apprehension. I can easily link my past decision-making and spending habits to my current credit score. Now, about that $200,000 home loan…

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