Debt Free

Because it's so vitally important to your personal finance picture, and as a tie in to yesterday's post on financial new year's resolutions, I'm going to cover the basics on how to raise your credit score. Your credit score is also called a “FICO score”, is named after its creator, the Fair Isaac Credit Organization. Weather you think Fair Isaac is actually fair (and balanced?) after seeing your credit score is a subject for another time. The FICO credit scoring system is one of the primary reasons that you can go online and be approved more or less instantly for a loan. Lenders no longer have to sift through and endless litany of documentation, because most things that affect you as a credit risk have been distilled down into a simple, three digit number for them.

The fact remains that this single, 3 digit number has a greater affect on your finances than any other. It almost single handedly determines the interest rate you'll pay for credit, weather you can get credit at all, and a slew of other, seemingly unrelated things in your life. Some of the other things that your credit score impacts these days include your eligibility and rate for insurance and rental housing.

What is a good credit score?
FICO credit scores range from 300 to 850, with higher being better. You'll see few at either extreme, just as you'd expect. The majority of U.S. consumers (27%) have a score between 750 and 799, and 58% have a score of 700 or greater. The average credit score varies with time, but is usually in the low 720's. Most lenders consider a score of over 750 very good, and that should make you eligible for good rates on loans and credit cards. Exactly what is considered a good credit score varies by lender, and in many cases by product, so the best policy is just to get the damn thing as high as possible. Recently, due to the problems in the credit markets, lenders have been getting a bit more skittish about who the lend money to, so where you could have easily gotten a good loan with a 705 last year, this year the same lender may be looking for a 745.

What makes up your credit score?
Your credit score is determined by 5 things; past payment history (35%), amount owed (30%), length of your credit history (15%), new credit (10%), and the type of credit you use (10%). Take note here, people, the single most important thing that FICO looks at when calculating your credit score is your past payment history. They consider the most reliable indicator of your inclination and ability to repay creditors your history of doing so in the past. The score is weighted so that recent late payments (the last 24 months or so) are more important than those in the more distant past. About 2/3s of Americans have no late payments showing on their credit reports whatsoever, so if you do, it definitely puts you in a minority you'd be better off avoiding.

The next most important aspect of your credit considered by FICO is how much you owe. This is not just the total amount of your debt, but the amount of your available credit you have used. This is also termed your credit utilization score, and is a very important component of your overall score. To increase this number your should pay off debt, especially revolving accounts, such as credit cards. The CUS is why you can adversely affect your credit score by closing unused accounts. Doing so will decrease your total available credit, and thus your score. The amount owed on revolving accounts is weighted more heavily than is debt from installment loans, such as car loans or mortgages. FICO actually looks favorably on installment loans that have a good payment history, so if you have a car loan that is 50% payed off, and you've never been late, that will help your credit score.

To prevent you from just applying from every credit card under the sun, and then not using them, as a strategy to raise your CUS, and with it your overall credit score, you'll note that another component of your FICO score takes into account any new credit you've opened. A large number of new accounts will decrease your credit score in the short term.

The length of your credit history is important in the grand scheme of things. Experience breeds contempt, but also a better credit score, in the eyes of the powers that be. How long you've been a creditor is also a reliable indicator of your risk for future creditors, so is included in your credit score. That is why you should get a credit card the day you are able, and begin building a credit history. In keeping with the larger components of the FICO scoring system and financial prudence, make all your payments on time and keep the balance fairly low.

Last but not least, FICO looks at what types of credit you use. They are concerned that you have multiple types of credit, so having a credit card and a car loan, for example will serve to raise your credit score. Ironically, your lack of a credit history will probably cause you to pay a higher interest rate on a car loan at first, but will repay you by allowing you to get a higher credit score, and lower interest rates on subsequent loans.

So, what does not affect your credit score?
How old you are isn't taken into account, so that is another reason to begin building a credit history early. If you are 25 years old with a 7 year credit history, you will score higher than a 25 year old with a 3 year history, all other factors being equal. They also don't factor in race, color, creed, or any other such nonsense, as well they shouldn't.

A common misconception is that the amount of money you make is included in your credit score, but is not. Salary or compensation isn't used as one of the determining factors in your credit score. Apparently there are just as many deadbeats making $100,000 a year as there are making $30,000. Something to note is that lenders themselves may look beyond your FICO credit score to consider your income, as when they calculate your debt to income ration when you are applying for a mortgage.

Something else that isn't included are all types of credit inquires. Some are included (hard pulls) and some aren't (soft pulls). When you check your own credit score, something you should do regularly in addition to getting a copy of your credit report, that will not affect your credit score in the slightest. If you are attempting to open a new account, that inquiry will give your credit score a minor ding (about 5 points) for 12 months, although it actually stays on your credit report for twice that long.

Your credit score will not take into account the interest rate you're paying on other financial obligations, so if you have a credit card that you're paying 22% on, that won't automatically lower your credit score.

So, to raise your credit score you should do the following:

1. Get a copy of your credit report. You are able to do this for free once a year from each of the 3 major credit reporting agencies; Equifax, Experian, and TransUnion. Stagger your requests so that you get one every 4 months. Look through it with a fine toothed comb and contest any inaccuracies that you find.

2. Make sure you make no late payments. If you have any delinquent accounts, clear them up at once. The sooner you clear them, the sooner they will fade far enough into the past so as not to adversely affect your credit score.

3. If you have no credit history, begin building one as soon as possible. The length of your credit history is very important to your score, so the earlier you get credit, the longer your history will be.

4. “Piggyback” This is way for you to use someone else's credit to bolster your own, and is especially powerful to increase your credit score if you are young and have little or no credit history. This is why it is a great idea for you to get attached to one of your parents credit cards if they have good credit. That card's history will be reported on your credit report and increase your credit score. Due to recent abuses, such as people renting their credit histories to those with abysmal credit, this technique is in danger of being eliminated.

5. Analyze at your credit profile. Do you have 22 maxed out Visa cards? Keep a healthy balance of credit types and, this is very important, do not close accounts you no longer use and have paid off. These old, paid off accounts are pure gold for your credit score. The increase the length of your credit history, and because they have no balance, they decrease your credit utilization score.
   

Hopefully this will increase you understanding of that all-too-important financial statistic, your credit score, and allow you to raise it so you can take advantage of lower interest rates, and better loans.