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Credit reports are long and dry, and using reports alone to determine risk can be subjective. Credit scores were introduced to be a more objective determination of how likely an applicant was to pay his or her bills. The first FICO score was calculated by Fair, Isaac and Company in 1989 as a way for banks and other lending institutions to determine an applicant’s creditworthiness more efficiently and fairly. The score ranges between 300 and 850; the higher the score, the better. View a breakdown of the score ranges.
Your credit score has never been more important than it is today, and a low score can have a detrimental effect at every turn.
How Does My Report Affect My Score?
While exactly how credit scores are calculated is a secret more heavily guarded than what’s in Area 51, there’s a general guideline for weighing various factors of your credit report.
Payment History: 35%
This not only includes your monthly payments going back two years, but it also includes negative information such as bankruptcies, judgments, foreclosures, liens, settlements, and charge-offs.
Burden of Debt: 30%
This part of your score looks at your debt-to-limit ratio (amount of debt vs. available credit), the number of accounts you have with balances, amounts owed on different types of accounts, and amounts paid on installment loans.
Length of Credit History: 15%
This looks at the average age of your accounts and the age of the oldest account.
Types of Credit: 10%
Having different types of credit (revolving, installment, mortgage, etc.) is good for your score.
New Credit: 10%
Opening several new accounts in a short period may indicate a greater risk.
How Can a Low Score Affect Me?
Low credit scores can have a huge impact on many aspects of your life. Bad credit can do everything from cost you a dream house to inflate your insurance premiums.
Cost You a House
Lower scores could cause you to be denied a mortgage or be charged a higher interest rate, which, when you’re talking about a 30-year loan, could cost you tens of thousands over the life of the loan.
Cost You a Car
You may be denied an auto loan entirely or have to turn to one of those auto dealers with a “Bad Credit? No Problem!” sign in front of it, which could mean an interest rate of 20% or more.
Make It Difficult to Get an Apartment
More and more property owners are taking steps to minimize their risk of renting by checking credit. If you have bad credit, you may get passed over for that new apartment or be required to pay a higher security deposit.
Affect Your Utilities
If you manage to get that mortgage with your poor credit, you may have difficulties getting your electricity, phone, and cable turned on. Utilities often check credit, and if your credit is bad, you may have to cough up a deposit before they’ll hook you up.
Cost You a Cell Phone
Cell phone companies check your credit. Bad credit may prompt them to charge you more upfront for a phone, sign you up for a month-to-month plan, or deny you service entirely.
Force Higher Insurance Premiums
Insurance companies believe that people with lower credit scores file more claims than those with good credit do.
Be Denied Your Dream Job
Employers typically check your credit if the position is one related to finance, or if it requires access to sensitive employee information. However, some even use your credit report to see how you handle your finances as an indicator of potential job performance.
Cost You a New Business
If you have plans for a new startup, you’ll most likely need a line of credit to start, which becomes more difficult if you have poor credit.
Cause Stress and Anxiety
When bad credit looms over you, it can cause a lot of stress and anxiety. If you’re getting married, your bad credit can drag down your spouse’s credit as you merge finances.
How Can I Improve My Credit Score?
Improving your credit score may take a little time, but with some determination, you can bring up your score. The key is to focus on the factors that FICO looks at.
- Get copies of your credit reports from all three credit-reporting agencies: TransUnion, Experian, and Equifax. Check them over carefully and formally dispute any erroneous information with the agencies.
- Concentrate on making all payments on time.
- If you have accounts with delinquencies, judgments, etc., try to pay them off first.
- Request higher limits. Sometimes, lowering your debt-to-limit ratio will improve your score. Remember, however, that the point is to increase your available credit but not to actually use it.
It may seem counterintuitive to what you’re trying to accomplish, but having some debt is good. If you have no debt, your credit history will lapse and your score will surely go down. To achieve a high credit score, you need to use credit responsibly and always pay your bills on time.
By taking the necessary steps to raise your credit score, more doors will be open to you, and you’ll save yourself a lot of money and stress in the future.