Anytime a consumer elects to finance the purchase of a product or service, the terms of the repayment agreement are greatly
affected by your FICO (credit) score. The FICO system is a credit scoring system created by the Fair Isaac Corporation and has been adopted by credit reporting services and lenders worldwide. The FICO score is typically the largest part of a credit decision process but not the only thing taken into consideration. Also,
your score is not considered for purchases alone. Employers, landlords, insurers and utility companies also consider this score as an indicator when deciding whether to do business with you.
The power of your credit score significantly influences the interest rate at which the consumer can borrow money or borrow
money at all. The scoring is from 300, the lowest score possible, to 850, the best score possible. Currently a score of 720 is a typical score for American consumers and represents the score a consumer should achieve. Anything lower means that you are falling short of the preferred American consumer and can expect to pay more in interest and deposits.
The Fair Isaac Corporation is a for-profit company and as such, is certainly not going to share its formula to the public. They do however; offer some basic guidelines for how the score is calculated:
Payment history – 35%
Amounts owed – 30%
Length of credit history – 15%
New credit – 10%
Types of credit used – 10%
It is interesting that many of the activities that contribute to a good credit score actually contradict what is taught by financial counselors. For example, keeping a zero balance in charge accounts is considered wise by a financial counselor but this same activity could negatively impact your FICO score. Also, according to the FICO system of scoring, it makes more sense to have $1,000 balance with 5 credit accounts with a $2,000 limit (total of $5,000 debt) than to have a $5,000 balance with 1 credit account with a $5,000 limit. Having many open accounts is good but having no accounts open is bad.
No matter the logic behind the scoring, the power of your score is in the high number and if you are looking to get favorable interest rates, you will need to take the steps necessary to influence the outcome.
Graphic Source: Lamb, Lori. Credit.org 22 Jan. 2014.
Your credit score is a major consideration for determining what you will pay for many goods and services. Not only does it affect how much interest you’ll pay on a mortgage loan, but it also may be used to determine what you’ll pay for the home insurance. Many consumers are caught off-guard when they discover their credit score has dropped significantly and thus impacted the interest rate on a home purchase. It is up to the consumer to be aware and regularly check this oh-so-important barometer of their credit worthiness.
The good news is you can order a free annual credit report from each of the credit reporting companies (Equifax, Transunion and Experian) once every 12 months. Any consumer can request a free annual credit report via one of the following three options:
It may make more sense however to order them separately at different times of the year so that you can monitor your credit throughout the year. Although the free credit report does not offer your FICO score, it does provide the information you’ll need to determine if it is accurate. There are instructions on the site for disputing the record and challenging any of the information presented.
The consumer should also be aware of other reporting companies that may provide information to the credit reporting companies. These are specialty reporting institutions that report your history for things like title loans, payday advances, insurance claims and other historical background information that could affect an interest rate or whether you get a job for which you have applied. If any of the information reported results in a negative result, the company is required to notify you of which reporting company provided the
information and how to contact them for your report, which is typically free.
Finally, every consumer should check their credit reports annually whether they are suspicious of a problem or not. The information provided to the reporting companies is collected by humans, and humans make errors. It is certainly possible to have a FICO score of 825 and also have errors in your file. And by all means, spend a few dollars each year to track your FICO score so you can be proactive with your credit worthiness.