Credit Rating

What Is This About?

There are three big credit reporting agencies in the United States: Equifax, TransUnion, and Experian. These companies keep big piles of information about almost everybody in the country.

Fair Isaac Corporation has created the "FICO score" that tries to measure the risk involved in giving somebody credit.

Many times in your life, you will apply for credit. It could be a loan to buy a house, a lease for a car, major credit cards, even rental of an apartment. Whenever you apply for credit, the lender will want some idea of whether or not you will be able to pay back any money that is loaned.

Basically, the lender will buy a credit report and FICO score for you. He will use this information to help determine whether or not you are a good risk.

This page helps you understand what information the lender is getting, how it may be used, and what you can do to take control of your financial future.

Why This Is Important

The Fair Isaac Corporation web site (http://www.myfico.com) gives several clear examples of how your credit rating affects your financial future: The higher your FICO score, the lower your payments!

This is from their web site, using interest rates accurate as of March 30, 2007 (the exact numbers will change over time, but the trend will always be the same):

30 Yr fixed mortgage
FICO score  APR     Monthly payment
760-850     5.810%  $1,762
700-759     6.032%  $1,805
660-699     6.316%  $1,860
620-659     7.126%  $2,021
580-619     8.703%  $2,350
500-579     9.753%  $2,578

15 Yr home equity loan
FICO score  APR     Monthly payment
740-850     8.502%  $492
720-739     8.802%  $501
700-719     9.302%  $516
670-699     10.077% $540
640-669     11.577% $587
620-639     12.827% $627

36 month auto loan
FICO score  APR     Monthly payment
720-850     7.148%  $774
690-719     7.955%  $783
660-689     9.439%  $800
620-659     10.984% $818
590-619     14.406% $859
500-589     15.017% $867

The point that Fair Isaac is making is that the lower your FICO score the more risky it is to lend you money, so the higher the interest rate asked by the lender. Those higher interest rates translate directly into a higher monthly payment, and more money out of your pocket in order to buy the same product.

So, it could benefit you greatly to know your creditworthiness and work to keep your record clean.

More About FICO

You don't have just one FICO score, you have three FICO scores, one for each of the credit reporting agencies. Here's why:

Each of the different credit reporting agencies has their own separate file on you. Most of the same information is reported to all agencies, so the reports will be similar, though not necessarily identical.
All of the credit reporting agencies can and do calculate your FICO score. This is part of what they sell to the companies that are evaluating you.
Although all credit reporting agencies use essentially the same basic FICO formula, the formula is run using whatever (slightly differing) data that the particular reporting agency has in their file, so each agency may report a slightly different FICO.

I don't know of any source for free FICO scores. The free credit report shows all the stuff that goes into the FICO, but not the score itself. If you want your FICO score, you have to pay for it one way or another. FICO may be included as part of a larger credit report that you buy, included as part of a paid credit monitoring service, or included in some other paid package.

In addition to selling you your FICO score, many credit reporting agencies often prefer to sell consumers (you) their own in-house credit score number "for educational purposes" instead of FICO. Since lenders don't use that in-house credit score, it may not be a good deal. My personal policy is to neither pay for nor trust any in-house credit scores. The score that everybody uses to evaluate me is FICO, so that's what I look for.

One place to buy your FICO score is Fair Isaac Corporation (http://www.myfico.com).

According to myfico.com, as of April 2007:

FICO scores are your credit rating.
They range from 300-850, higher is better.
Most lenders base approval on them.
Higher scores mean lower interest rates.
The median FICO score in the U.S. is 723.
FICO scores are calculated based on your rating in five general categories:
- Payment history - 35%
- Amounts owed - 30%
- Length of credit history - 15%
- New credit - 10%
- Types of credit used - 10%

According to other sources:

850 - best possible
700-720 (depending on lender) = "prime"
700 - average
620 or lower = "sub-prime"
300 - worst possible

But no matter what category you fall into, it is clear that the higher your FICO, the better the loan you can get.

Who Are The Key Players And What Do They Do?

The individual credit reporting agencies are:

Each of these agencies keeps their own file on you.

Fair Isaac Corporation (http://www.myfico.com) invented the FICO score and license it to these same credit reporting agencies. Whenever one of these credit reporting agencies computes your FICO score, they pay a royalty to Fair Isaac Corporation.

A special web site has been set up to make it easy to get the free annual credit reports to which you are entitled by U.S. law. See http://annualcreditreport.com.

Note: All of these sites/agencies will try to sell you additional goods and/or services. I don't buy any of the extra-cost stuff.

Your Rights

By United States Federal law, you are entitled to one free credit report, for each credit reporting agency, per year (total 3 free reports/year).

The free credit reports do not include your FICO score. Presumably this is because one has to pay royalties in order to generate a FICO. The free credit reports do contain all the information that goes into computing your FICO.

You have the right to dispute errors in your credit report and have them corrected.

If you are refused credit:

You have the right to get the reason why if you ask within 30 days.
You have the right to a free credit report within 60 days.

For more information on your rights, contact the various Key Players or look under For More Information.

Steps One Might Take

There are various steps that one might take to become more aware of one's credit rating and strive to protect or improve it:

Get one or more of the free credit reports to which you are entitled.
Buy one or more of your credit reports and/or FICO scores.
Enroll in a credit monitoring service.

A Plan Of Action

In general:

Get copies of your credit report regularly.
Check credit report for errors and ask to have them corrected.
Check credit report for signs of fraud or identity theft and act on it fast.

By United States Federal law, you are entitled to one free credit report, for each credit reporting agency, per year (total 3 free reports/year). Most of the same stuff is reported to all agencies, so the reports will be similar, though not identical.

Strategy:

Every four months, get one report from a different agency.
This allows you to get regular credit updates, without paying.

My schedule is now:

Equifax - April 1
Experian - August 1
TransUnion - December 1

To get a free credit report, go to http://annualcreditreport.com This site will allow you to pick one or more credit agencies and generate a report. As said earlier, my plan is one agency every 4 months. Have a printer connected to your computer, loaded with paper and ink - when I used Equifax, it would let me view or print the report, but not save it to disk. [There is a geek way around this limit: tell your browser to "view source" and then save it as a file.]

Ways To Improve Your Credit Score

There are numerous companies that advertise that they can fix your poor credit. Any such organization that is operating within the bounds of the law can only do the same things that you can do yourself, so they are generally not a good deal.

General ways to improve credit scores:

Pay bills on time! This is #1!
If you missed payments, get current and stay current.
Keep unpaid credit card balance low.
Pay off debt rather than moving it between cards.
Apply for and open new credit accounts only when you need them.
Check credit report regularly for errors.
Closing accounts doesn't help because closed accounts stay on your record. Closing many credit accounts at once can hurt.
- Instead, pay them off, leave them paid-and-open.
- If you want to get rid of them, close them gradually over a period of time.
Don't use over 30% of your total available credit.
When looking/shopping for a loan, make all inquiries within 14 days.

For more help in this area, see For More Information.

Closing Credit Cards

Closing accounts doesn't help your credit rating because closed accounts stay on your record. In fact, closing several credit accounts at once can hurt your credit report.

If you want to close credit card accounts:

Close accounts that have low credit limits.
Close newer accounts instead of ones that you have had a long time.
Close retail store cards (e.g. Home Depot) instead of more general cards (e.g. Visa).
Close accounts slowly, over time.

For More Information

The Fair Isaac Corporation web site (http://www.myfico.com) has several free brochures.

As of April 2007, the documents are located at http://www.myfico.com/Downloads/Brochures.aspx and consist of the following:

Your Credit Scores
Understanding Your FICO Score
Identity Theft and You