What is Credit?

In the past ten years, credit score commercials seem to have popped up out of nowhere, sending out cautionary messages about the woes of allowing your credit score to ruin your life. Yet, you might not know exactly what a credit score is or how to keep it at its correct numerical value. Credit scores can greatly impact your financial future and your ability to hold jobs, rent apartments, and even purchase a vehicle. This little number with so much power is determined by credit bureaus and cited on your credit report, but how is the number sourced? You might wonder what steps have been taken to determine your personal score and how that number can wax and wane depending on your financial choices. Your creditworthiness speaks loudly as to your ability to handle money and debt. If you have a solid grasp on the meaning behind your credit score, you can prevent it from sinking below where it should be.

Credit Reports Defined

Credit scores were developed by Fair Isaac and Company. Initially, neither your credit score nor credit report were public domain, as Fair Isaac and Company assumed that consumers would needlessly worry over a number they couldn’t control or comprehend. However, in 2001, Congress changed the laws in favor of releasing credit scores to the public in lieu of a fee. Your credit score is a three-digit number that has been deduced by a special algorithm based on the data contained within your credit report. It is intended to help lenders assess whether or not you can be trusted to pay off your credits.

When you apply for a loan from a bank, they use your credit score to determine what your interest rate should be. If, in the past, you have been unable to pay bills on time or have broken a lease, this can be a red flag and will reflect negatively on your credit score. Lenders will subsequently see your negative trend and might think of you as less trustworthy. Some of the things that can affect a credit score include the amount of late payments you’ve made, the number of accounts you have, and your debt. Your salary and employment history may not be factored into your credit score, nor can your personal or demographic information. While you are eligible to get a free credit report once a year from each credit reporting agency in accordance to Federal Law, they are not required to provide you with a free credit score. To receive your actual score, you will have to pay for it through a score provider.

In the United States, there are three major credit bureaus that tabulate credit reports for American citizens: Experian, TransUnion, and Equifax. The FICO (Fair Isaac and Company) scoring method is the most popular one in the United States and is used by all three major credit bureaus. A FICO score can range anywhere from 300 to 850, with the average score resting around 680. The higher your number, the better, although there won’t be much of a difference between a score in the low 700s and a score of 800 or more, as you will already have a high enough score to have low interest rates and apply for loans. While all three credit bureaus once provided the consumer with a FICO score, it is now only provided by TransUnion and Equifax given that Experian dropped FICO in 2009. FICO’s score rests most heavily in your payment history and your personal debt. While other factors such as length of credit history, new credit, and types of credit used are also taken into consideration, they embody a much smaller margin of the overall score.

The amounts-owed portion of your FICO score, which encompasses 30% of your credit score, takes into account things like credit card utilization. Utilization is the debt-to-credit limit ratio for your accounts, and while you’re looking for a low balance, you don’t actually want it to be a zero balance. The score is higher if there is some, if small, activity. Thus, not using your card ever could negatively impact your credit score. If you continue to let it sit with zero charges, the issuer may close the account, affecting your utilization.

Getting and Keeping a Good Score

Frustratingly enough, individual rocks along the road may affect your credit score at varying degrees depending on how many credit cards you have or loans you’re working off and so forth. Your score is calculated alongside other consumers with similar credit profiles, each with a specific formula. The groups and their paired formulas are called scorecards. If you declare bankruptcy, for example, you will be placed in a scorecard group with other bankrupt consumers.

To get a good credit score, there are essentially three basic rules to follow; paying off you bills and loans on time, staying out of credit card debt, and continually establishing credit. Establishing credit can be the hardest component to a good credit score, because you can’t have a credit score without any credit. This is best done when you’re young and can be achieved by taking out a federal student loan for college, being authorized on a parent’s credit card, taking out a loan with a cosigner, or, of course, obtaining a secure card. A good credit score will not immediately follow, but will take some time to develop. Likewise, you may have a budding credit score in college, and may not realize how much damage a late bill can have on your credit score. A fledgling credit score that is likely already somewhat low shouldn’t be marred by a lazy late payment, even if the monetary cost of a late bill is slight. Lastly, while it is good to carry a credit card or two, it is a moot point if you have any credit card debt.

You should also take into consideration the effects of a credit card balance transfer on your credit score. You may be enticed by a credit card offer you received that collects low or no interest, a deal when compared to your current credit card with rising interest fees. However, before you transfer your balance to a new card, it is key that you consider several factors that will determine whether or not this move could have a negative effect on your credit. For example, your debt percentage may skyrocket if you choose a card with a lower limit, having an adverse effect on your credit score. To be safe, you should always try and transfer to a card with an equal or higher limit to avoid this pitfall. Second, you should avoid doing too many balance transfers because a credit check is performed with each one, and a surplus of inquiries will harm your score. Finally, if transferring your balance to another card enables you to pay off your debt faster because of the lower or non-existent interest rate, it is probably a wise investment. Lenders will take kindly to the idea that you utilized the balance transfer to pay off your debt rather than moving it around as a means to avoid it.

Incurring a Bad Credit Score

The worst possible FICO score is 300. The main reason you don’t want a bad credit score, aside from having difficulties getting lenders to trust you, is that fact that your interest rates will climb up and you’ll ultimately spend more paying off your debt. Given that your payment history is 35% of your credit score, late payments are the most common culprit for bad credit. Even if you’ve never missed a payment and have a credit score between 700 and 800, your score could drop by as much as 100 points by missing the 30 day cut-off for paying your bills. This is known as a credit delinquency. In most cases, delinquency isn’t reported to the credit bureaus until two consecutive payments have been missed. Having the delinquency on your record puts you in a different scorecard group, and while it may have only taken one bad month of a late payment to get there, it could take far longer to revive your score.
Furthermore, maxing out your cards will unquestionably bring down your FICO score. It is important to keep your balance in check with your credit limit. Generally your balance should not exceed 35% of your credit line, according to CNN Money. Showing self-restraint on your spending to avoid nearing your credit limit looks good to lenders.

Closing out old credit cards is another symptom of a bad credit score. You might think that you have too many, and you’d rather condense and get rid of some of the old ones you rarely use. Yet, doing so can mar your credit score because it eliminates some of your valuable credit history. On the other hand, you want to avoid opening in-store credit cards too often, such as a Gap card or Neiman Marcus card. While these cards may allow you to get discounted items within their stores, utilizing several of these cards at once appears as questionable behavior to credit agencies, resulting in a lowered FICO score.

You can also wound a perfectly good credit score by ignoring what you perceive as nominal fees. You may think nothing of your Blockbuster late fees or a couple of unpaid parking tickets, but you never know whether or not these miniature debts will be reported to collection agencies. Collection agencies will, without fail, report such misdemeanors to credit bureaus where your score will take the brunt of your erroneous behavior. Overdue library books, unpaid gym membership fees, and even school lunch bills can and have been turned over to collection agencies.

Salvaging a Credit Score

Now that you know what constitutes a good or bad credit score, you might be wondering how you can improve an already low credit score for the better. Reversing bad credit takes time, but absolutely can be done. To mend your credit score, myFICO suggests you simply begin paying off debts and managing your credit responsibly. To take a step in the right direction, check your credit report, which could possibly contain errors. Calculate your score yourself to make sure that it all adds up, including any incorrectly stated late payments. Begin paying your bills on time and utilize payment reminders to keep yourself on track. You can even set your accounts to auto-pay to take human error out of the equation. Likewise, if you have credit card debt, begin taking steps to reduce that debt with a budget plan. Refrain from using your credit cards while you work to pay off your debt. Little by little, your good credit habits will transform your score for the better.

In terms of your wounded payment history, you will just have to wait it out and be on good behavior until it heals. It takes seven years for missed payment delinquencies to disappear from your report, and you can’t pay anyone to remove it before then. Credit Repair scams do exist, but are easy to identify. If a company is trying to sell you on the idea that they can quickly mend your credit score, enabling you to finally buy a house, car, or insurance, know that there is no quick fix and you’re being taken advantage of. The company will require a fee in exchange for a clean credit score, but it is illegal for credit repair companies to wipe away negative history from your report and they don’t have the means to do so. The Federal Trade Commission offers some pointers for sniffing out a scam — to avoid paying hundreds or thousands of dollars in fees with no actual benefit to your credit you’d be wise to look out for the following signs.

First, the Credit Repair Organizations Act deems that credit repair companies cannot require you to pay until they have provided you with the services agreed upon. Thus, if a credit repair company is pressuring you to pay before they begin to work out the kinks in your score, know that they will likely take your money and run. The company should also give you advice as to what sort of things you can do to help your score without their aid and what sort of rights you have as a consumer. If the company asks you not to contact Experian, TransUnion, or Equifax, they are likely not a legitimate credit repair company. You should also be wary if they advise you to contest correct information on your report or promise that they can alter correct information. Lastly, a company that suggests you fabricate a new credit identity by applying for an Employer Identification Number is operating illegally and should not be trusted.