Tess Rowland, Solutions for Wealth Management, Bourbonnais, Ill.
Recently, I met with a couple who had been struggling to manage their credit card debt. Together, they had accumulated more than 30 different credit cards, many of which had outstanding balances. They wanted to know how to manage their current credit card debt and how to close some of their credit cards without adversely affecting their credit rating. What they found when they attempted to research the subject was confusing and frustrating. This article, based on material from myfico.com, introduces some basic information for those who want to know more about credit, credit ratings and credit scores.
Credit Report and Credit Scores
There is a big difference between your credit report and your credit score. A credit report provides detailed information about your use of credit (historical and current). Credit reports are generated from three U.S. credit bureaus: Equifax, TransUnion and Experian. Reports contain data about inquiries, credit card and loan account information, and any relevant collection or public records. The Fair Credit Reporting Act allows consumers to access their credit report at no charge on an annual basis from each of the credit bureaus.
A credit score is obtained from the information provided on the credit report. You receive a different credit score each time you request one because the score provides a snapshot of your credit and loan balance status on a given date. Credit scores range from the low 300s to the 800s. The higher the credit score, the better. A credit score helps lenders gauge whether borrowers will pay their bills on time.
You can receive your complimentary credit report annually from each of the three credit bureaus, but you won’t receive your credit score for free.
What is FICO®?
The FICO® score is the primary scoring model most lenders use to make their loan decisions and to set applicable interest rates for the loans. Because the credit bureaus are independent, they have their own version of the FICO® score based upon the information they have available.
According to myFICO.com, there are five elements that comprise your FICO® credit score (listed in order of importance): 1) payment history, 2) amounts owed, 3) length of credit history, 4) new credit and 5) types of credit used. Let’s look at each of these elements in a little more detail.
This element is the biggest part of your FICO® score. A good payment history will increase your FICO score. Payments that are 30 days past due are reported to the credit bureaus as late.
The utilization ratio is a measure of how much you have maxed out your credit cards. High utilization ratios can be an indicator that you are overextended and you could be at risk for making late or missed payments in the future.
Length of Credit History
The length of credit history involves assessing how long you have had credit cards and how much time has passed since you used the credit cards.
Multiple inquiries can be an indication that you are shopping for credit. An example would be opening a retail store card to take advantage of an offer to “save 10 percent on today’s purchase.” Too many new credit inquiries can adversely affect your credit score.
Types of Credit Used
Your credit score includes the types of credit you have, including mortgage loans, car financing loans, bank-issued credit cards and retail shopping cards. This area is of interest when it is difficult to determine the credit worthiness of relatively new credit card applicants with little or no prior credit card history.
You Control Your Score
The choices you make can have a big impact on how your credit score works — for you or against you. Here are a few suggestions:
- Keep the number of credit cards to a minimum. Review the list of cards in your credit report. If you feel you have too many, close cards you do not need and/or have high interest rates, but keep in mind that the FICO® score is based primarily upon your payment history, so having a longer history is better. Closing old credit card accounts makes your credit history appear shorter, so consider closing recently opened cards.
- Don’t miss your payments.
- If possible, pay off your balances in full each month.
- Think twice about filling out new credit card applications. Multiple inquiries can lower your credit score.
- Avoid creating high over-utilization ratios. Don’t let your balance reach the maximum credit card limit.
Check your credit report regularly. In addition to the FICO® credit score, the three credit bureaus provide a free report annually upon your request. Review the reports carefully and contact the credit bureau and/or reporting agency if you notice any discrepancies.
For additional information, please visit myfico.com.
To learn more about the three credit bureaus, visit the following sites:
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