Back in high school, I was a mediocre student, a kid whose report card often read "doesn't work up to her potential." But in college, something strange happened: I started to do remarkably well. As good marks replaced average ones, I became obsessed with grades, viewing anything less than an A as totally unacceptable.
In the real world, however, our actions — mercifully — are rarely graded. That is, with one very notable exception: the almighty credit score. If you aren't already familiar, the credit score is a single number used by credit-card companies, auto- and mortgage-lenders, and even many landlords, to assess a borrower's worthiness. I recently pulled mine, and once I got over the initial shock that I was — gasp! — in the middle of the class rather than the top, my old college competitiveness kicked in. Not since the first day of a new semester have I seen my goal so clearly defined.
Fact is, everyone should be zealous about establishing and maintaining a high credit score, since it can save thousands in interest payments. Consider that someone with a top-notch credit score could pay 5.9% today for a 30-year fixed-rate mortgage, while someone with a poor score would pay 9.3%, according to Fair Isaac & Co., a California-based company that calculates the scores used by most banks and mortgage lenders. On a $200,000 30-year mortgage, that's a difference of nearly $167,879 in interest payments over the life of the loan, according to HSH Associates.
Given the importance of maintaining a good credit score, it's downright infuriating that so many credit reports (which is what your score is based on) contain errors. According to a 2004 study by the Public Interest Research Groups, or PIRG, as many as 79% of credit reports have errors — 25% of which are serious enough to potentially result in a credit denial. "If you have a very good credit score or a very bad credit score, you're probably being treated the way you deserve to be treated," says PIRG's Ed Mierzwinski, a consumer advocate. "But if you're in the middle, the odds are good that mistakes in your report will affect your score marginally enough to cause you to pay too much."
Financial planners suggest consumers check their credit report at least once a year. And if they're planning a major purchase, like a house, they should pull their report and score roughly six months ahead of time, so they can fix mistakes or take strategic steps to push their score higher, if needed. Since there are three credit bureaus — each with its own credit file — consumers should check all three reports before taking out a loan. Frustratingly, many mistakes will appear on just one of the reports. So just because one of the bureaus says a consumer is clean doesn't mean he or she is in the clear.
Here's what you need to know about credit scores, along with some point-boosting strategies.
Know the Score
The most widely used credit score by lenders is the FICO score, provided by Fair Isaac & Co., and available to consumers at Fair Isaac's consumer Web site, myFico, as well as Equifax, one of the three credit bureaus. Similar scores can be obtained from the two other credit bureaus, TransUnion and Experian, as well as some of the companies that compile the data of all three credit reports, like TrueLink, which operates the consumer-credit Web site TrueCredit.
A FICO score can range from 300 to 850. The very best rates often go to people with scores above 760, but lenders may consider a score of 700 to be good (the median score is 725), says Craig Watts, Fair Isaac's spokesperson. If your score is below 620, it's time for concern. "As you start dipping below about 600, you see this dramatic increase [in lending rates]. So with every 20 points - going to 580, 560 - you're ramping up aggressively," says E-loan's senior vice president Pete Bonnikson.
Obviously, the first step to increasing your score is to know where you currently stand. The good news is pulling your credit report and score is easier and cheaper than ever. Even if you've recently been denied credit, are unemployed and plan to apply for a job within 60 days, think you may be a victim of fraud or are on welfare, you're still eligible for one free report per 12-month period from the web site Annual Credit Report. Residents of Colorado, Maine, Massachusetts, Maryland, New Jersey and Vermont are also entitled to one free report per year. Lucky Georgia residents get two.
It is indeed possible to increase your score by a significant amount — even over a period of four to six months, says Lydia Sermons-Ward, spokeswoman for the National Foundation for Credit Counseling. She ought to know: In anticipation of purchasing a new home, she recently managed to increase her score by 50 points in half a year.
To see which factors affect FICO scores, look at the pie chart above. Unfortunately, there are no tricks or gimmicks that will give your score a quick lift: Mostly you just need to use common sense. Not surprisingly, the most important thing to do is simply pay your bills on time. Just one late payment could cause your score to drop by as much as 100 points, says Fair Isaac's Watts, although it will vary significantly based on an individual's credit history. The more recent the late payment, the more it will affect your score. Other tips:
- Pay down your cards — Shocker: Reaching the upper echelon of your card limit doesn't do you any good. Nor does having many accounts with balances, even if they're small. So pay down any balances you can.
- Talk to your lender — It's usually impossible to remove accurate information from your credit report. But not always. Should you have a long and previously unblemished relationship with a lender, you might in fact be able to get an accurate item removed, says Gerri Detweiler, author of "The Ultimate Credit Handbook." So it could be worth a call or letter describing the circumstances around the late payment and asking that certain data be taken off the report. This certainly won't work, however, for repeat offenders, and consumers should never believe a credit-repair agency that promises to remove all accurate information.
- Fix mistakes — If you notify a credit bureau of a mistake on your report, it has 30 days to complete an investigation. This entails getting in touch with the lender to verify that the information is accurate. If the lender can't confirm (or doesn't respond), then the information is removed. If you have paperwork proving that information on your account is false (such as divorce papers proving you aren't responsible for new debts incurred by your ex-husband), send it to the credit bureaus. Just be sure to keep a copy of all correspondence.
- Hang on to your old card — Loyalty is rewarded, so you may want to hang on to old cards, even if you rarely use them. That's because 15% of your score is based on the length of your credit history, and that includes the age of your oldest account as well as the average age of your accounts. Translation? Lenders don't want a customer who's just going to move on once that nice introductory offer runs out.
Fortunately, a cottage industry in credit-score deciphering has popped up in recent years. At the myFICO Web site, for example, you can see which mortgage or home-equity-loan rate you should be eligible for based on your score, and how much you could save by increasing it. Purchasing a report from the site will also give you access to a score simulator, which offers guidance on how certain moves (such as paying down your debts) could increase your score. Also, most credit scores, regardless of where you pull them, now come with a personalized explanation of why your score is what it is, based on both your positive and negative factors.
You may have heard of other ways to boost your score — like spreading your debt onto more credit cards rather than keeping high balances on a few. But the truth is, that won't always work to your advantage. That's because your FICO score isn't the only score on which you're judged — it's simply the only one made available to you. There are many other scores out there, including behavioral scores, revenue scores and the highly controversial insurance scores. Many lenders also have their own proprietary scores.
So you never know how trying to game the system may hurt you. Some industry experts think that in the future, more scores may become available to consumers. In the meantime, you're best off sticking to the basic credit-boosting tips outlines herein.
If It Sounds Too Good to Be True...
No matter what, don't fall prey to a sleazy credit-repair scam. "It's tough to find a reputable company in the field," says Holly Cherico, spokeswoman for the Council of Better Business Bureaus. Many of these firms use illegal practices, while others charge you exorbitant fees for things you can do on your own for free. And remember, you're providing a credit-repair agency with highly valuable information, such as your social-security number and account numbers. Poor judgment here could leave you significantly worse off than when you started.
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