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A shocking 20%
In February of last year, the Federal Trade Commission released a study that was very eye opening. It had found that 20% of us have errors in at least one of our three credit reports. Even worse, about 5% of us have mistakes in our credit reports so serious they could be causing us to pay more for products such as insurance and auto loans.
You should also know your credit score. It's critical because most lenders look only at it when deciding whether or not to grant you credit. Your credit score is a three-digit number that is a sort of distillation of your credit reports. It's created using a formula or algorithm that was created by the Fair Isaacs Corporation or what is now known simply as FICO. You can get your credit score on its website, www.myfico.com or from one of the three credit reporting bureaus or from an independent information provider such as CreditKarma.com or CreditSesame.com. If you choose to get your score from FICO you'll either have to sign up for a free trial subscription of his Score Watch service or pay $19.95. While you can get your credit score free from one of the credit reporting agencies, be careful and don’t sign up for a service that you will have to remember to cancel. We think CreditKarma.com or CreditSesame.com might be your best options as you could get your score free from either one of them without having to sign up for anything. These two websites provide other helpful information such as the amount of money you owe on each of your credit cards, the amount of your mortgage and auto loan (if applicable) and tips for managing your debts. Finally, if you have a Discover Card you’re in for a nice surprise. Check out your next statement and it should include your FICO credit score. How cool is that?
Understanding your credit score
As you might guess, the higher your credit scores the better. Your FICO score will be somewhere between 300 and 850. There is also a score that was developed by the three credit bureaus called the AdvantageScore. It's a bit different in that it ranges from 501 to 960. To make matters even more complicated, each scoring model uses a different algorithm and weighs your credit report differently so you might have a score of 750 from Credit Karma and a 762 from Credit Sesame.
The components of your credit score
While there are more than 100 different credit scoring models used in the industry, there is one thing that seems to be universal and that is the five components that make up a credit score. They are.
- Your credit history
- Your utilization of credit
- How long you’ve had credit
- Types of credit you’ve used
- Recent searches for credit
Of these five components the first two – credit history and credit utilization – account for 65% of your credit score. Your credit history is just that or how well you have used credit in the past. Credit utilization is a bit trickier as it’s really your debt-to-credit ratio or how much credit you've used versus the total amount of credit you have available. For example, if you have $5000 in total credit limits and had charged up $2500 you would have a debt-to-credit ratio of 50%, which would be too high.
Unlike your credit history, credit utilization is something you have control over. You could improve it and get a better score. All you would have to do is pay down some of your debt and presto! Your credit score should increase.