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Understanding & Improving Your Credit

Your credit history has a significant impact on many facets of your life.  Lenders, employers, landlords, and other service providers obtain your credit information in the form of a credit report to help them decide whether to approve your application for a loan, credit card, job, or housing. Not only is approval based on credit report findings, but the actual rate and terms offered to you on loans and credit cards – even the premiums on your home and auto insurance policies – are based on the details found in your credit history.

With much of your personal information available to these providers, it is important that you have access to the information shared about you. You want to know the information is accurate and have the opportunity to refute any errors in your credit history.

All consumers are eligible for one free annual credit report. It is recommended that you review your credit information regularly to check its accuracy since credit files change often. Knowing what is in your credit report is only half the story; your credit score is the best indicator of the overall health of your credit.

What Information is Included in Your Credit Report?

Personal information is compiled from credit applications you have completed. This information normally includes your name, current and recent addresses, Social Security number, date of birth and current and previous employers.

Your credit history consists of details about credit accounts that were opened in your name or that list you as an authorized user (such as a spouse’s or parent’s credit card). Account details, which are supplied by your creditors, include the date the account was opened, the credit limit or amount of the loan, the payment terms, the balance and a history that shows whether or not you have paid the account on time. Closed or inactive accounts, depending on the manner in which they were paid, stay on your report for 7 to 11 years from the date of their last activity.

Credit inquiries are recorded whenever your credit report is requested by another party, such as a lender, service provider, landlord, or insurer. These inquiries remain on your credit report for up to two years.

Public records are obtained from government sources such as courts of law. Matters of public record – including liens, bankruptcies, and overdue child support – may appear on your credit report. Even unpaid parking tickets can appear as a collection account. Most public record information stays on your credit report for seven years.

What is a Credit Score?

A credit score is a numerical rating used by a lender to help determine whether or not you qualify for a particular credit card, loan, or service. The credit reporting agencies apply certain risk factors to the information in your credit file to yield your credit score. Credit scores estimate the risk a company incurs by lending you money or providing you with a service – specifically, the likelihood that you will fail to make payments in the next two to three years. Credit scores generally range from 300 to 850. The higher the score, the less risk you represent to the lender.

While consumers can receive a free credit report once a year through www.annualcreditreport.com, credit scores are not included. It is a good idea to purchase your scores through this website for the three credit reporting agencies – Equifax, Experian, and TransUnion. They each have a slightly different mathematical model for scoring and may actually have different information for one or more of your accounts. It is not uncommon for your three scores to differ by 20 - 30 points. A higher difference in scores may mean one or more bureaus have incorrect information or that certain information was not reported to all three bureaus.

Top 5 Factors that Affect Your Credit Score

Each of the credit reporting agencies weighs credit factors differently, but most credit scoring models are based on the following factors:

Payment history. This, including matters of public records such as bankruptcies, judgments, and collection items generally accounts for approximately 35% of your credit score.  Public records and late payments within the last year or two will have the greater negative impact, but the impact will be reduced with each subsequent year of good credit.

Length of credit history. In general, a longer credit history is better and will likely have a positive impact on your score. Credit history typically accounts for around 15% of your credit score.

Inquiries and New Accounts. Whenever someone, other than you, requests your credit report – a lender, landlord, or insurer, for example – an inquiry is recorded on your credit report. A large number of recent inquiries may negatively impact your score. Your new credit accounts and inquiries generally make up about 10% of your score.

Amounts owed. A high balance relative to the limit on an account may negatively impact your score. It is preferable to show that you are not maxing out the credit available to you. Keeping your balance on each revolving account below one-half of the limit may increase your score. Approximately 30% of your score is based on this category.

Types of Credit Used.  Having experience with different types of credit – perhaps installment debt, such as a car loan, and revolving debt, such as credit cards – can help your score.  If possible, avoid “finance company” type credit accounts.  Mortgage loans, installment loans and revolving credit card accounts impact your score more favorably than finance company accounts.  The types of credit you use make up approximately 10% of your score.

How Can You Improve Your Credit Score?

If you have had poor credit performance in the past, credit scoring does not let that haunt you forever. The impact of past credit problems fades as time passes and as recent good payment patterns show up on your credit report. Even if you have had a satisfactory payment history, taking steps to improve your FICO scores can often help you qualify for better rates from lenders.

Your scores will improve over time by managing your credit responsibly and by following these credit basics:

Obtain your free credit report annually from the three credit bureaus by visiting www.annualcreditreport.com to confirm that the information in your credit report is correct. Have incorrect or erroneous information updated.

Pay down high credit card and revolving account balances, but do not close the account. If possible, keep your balances below 30% of the limit on your account. When your balance is paid off, use the account every few months for a small item that you can pay in full the following month. This will keep the account “active.”

Avoid moving credit balances from one account to another just to take advantage of low introductory interest rates. The combination of “inquiries” and “new accounts” can negatively impact your score.

The best repair for serious credit issues such as bankruptcies, liens, and collections is to re-establish credit accounts. This might be through your bank with a “secured” credit card; when you demonstrate your ability to be responsible with your payments, you can ask for an unsecured card with possibly a higher limit. Remember to keep your balance low so you can pay it in full each month.

Avoid “finance company” type credit accounts.  These send a negative message that you probably accumulated too much debt and went to a finance company to help you bail out.

When you are applying for financing, such as a mortgage, having a credit history is important. While it is admirable that some people have the discipline not to purchase what they can not pay for in cash, this does not translate to a “credit history.” When these individuals purchase a high-ticket item such as a car or home that requires a loan, there is no history that can feed into a credit score, and these people are at a disadvantage. It’s true they have not purchased what they could not afford, but they have also not been able to show that they can handle revolving credit and on-time payments. Having a credit history—and credit scores--often allows lenders to make “instant credit” decisions in a fast, objective way.