MONEY MANAGEMENT 5

Your Credit Score–A Number to Know

While credit allows you the convenience of buying something now and paying for it later, you pay a premium, known as interest, in order to do this. Just how much interest you will pay is determined largely by your credit score, a number that lenders use to assess your credit worthiness and to determine whether they will give you a loan and at what interest rate.

When you go to a lender and ask for a loan by filling out a loan application, you authorize the lender to pull a copy of your credit report. Your credit report is maintained by three national credit-reporting agencies—Experian, Equifax, and TransUnion—that compile and report a variety of information on you, including personal identifying information.

Your credit report contains your full name, current and previous addresses, home and work phone numbers, Social Security number, marital status, date of birth, and current and previous places of employment. It also includes information that is a matter of public record—bankruptcies, tax liens, and any judgments filed against you.

A list of creditors who have extended you credit, what you currently owe them, and whether you have paid your accounts on time will also appear on your credit report. Most banks, credit unions, finance companies, and mortgage lenders report information to the credit bureaus.

Anytime you apply for credit, an inquiry is made on your credit report. Lenders may view too many credit inquiries in a short period of time as a potential warning sign, and may ask you why you are applying for credit with so many other lenders. These types of inquiries, however, are different than what are known as soft inquiries. A soft inquiry will appear on your credit report when you receive an unsolicited credit card offer in the mail.

Thanks to the Fair and Accurate Credit Transaction Act, you can now get a free copy of your credit report every year.If you request a credit report by mail, you must include a form with your request. The form is available for download at the Federal Trade Commission’s website at www.ftc.gov/credit.

When you request your credit report online, you will be asked to provide your name, address, previous address, Social Security number, and birth date. You can choose to receive a report from all three credit bureaus at once, or you can choose a report from one bureau, wait four months, and choose one from another bureau. This allows you to have a new copy of your credit report throughout the year. At a minimum, you should review your credit report yearly.

Review your credit report carefully to make sure there aren’t any errors. If you find errors on your credit report, you need to contact the credit bureau where the report came from to dispute the incorrect information. You may be asked to fill out a form provided by the credit bureau. The following is a sample letter for filing a dispute.

Not everyone has access to your credit report. Businesses that extend you credit and employers can view your credit report with your permission. However, someone such as your neighbor does not have access to your credit report.

Some credit reports will include your credit score, a three-digit number that ranges from 300 to 850 that is based on a calculation or scoring method. Unfortunately, the free credit report you receive by going to www.annualcreditreport.com will not include your credit score. For an additional fee, ranging from approximately $5 to $7, you can receive your credit score with your free credit report.

The most commonly used credit score is called a FICO score, based on a calculation created by Fair Isaac and Company.

Your credit score is based on the following:

• Your payment history- Have you paid your accounts on time?
• Your outstanding debt- What percentage of the credit available to you are you currently using?
• Your credit history- How long have your accounts been open?
• Credit applications- How much credit have you applied for, and how many inquiries have been made in the last twelve months?
• New lines of credit- How many new lines of credit have you actually opened in the last twelve months?
• Your credit mix- What type of credit has been extended to you?

Interestingly, your income is not a factor in determining your credit score. Research has shown that how you have paid your past debts is the best indicator of how you will pay your debts in the future. Based on this research, how much money you make is not a good indicator of whether or not you will pay your bills on time.

Lenders use your credit score as an indicator of your likelihood of repaying the credit granted to you. If you have a higher credit score, a lender views you as more likely to repay your debts on time. On the other hand, if you have a lower credit score, a lender will believe you are more likely to make late payments.

Because your credit score is directly related to your likelihood of making timely payments, the lower your credit score, the higher the rate of interest lenders will charge you to use credit. And the higher your credit score, the lower the interest rate you will pay.

Take a look at the examples that follow to see just how much your credit score affects the loan terms offered to you.

If have a credit score of 580 and want to borrow $25,000 to purchase a car on a five-year loan, you might expect to pay close to 18% in interest. In contrast, with a credit score of 720, you would qualify for a much lower rate. For purposes of this example, let’s say you qualify for a loan rate of 5%. Over the life of the loan, a person with a credit score of 720 will pay $9,375 less in interest than a person with a credit score of 580.

If you want to borrow $150,000 for a thirty-year home mortgage, and you have a credit score of 720, you could qualify for an interest rate under 6%, but if your credit score is lower at 580, the interest rate you will pay will be roughly around 9%. Over the life of the loan, the person with a credit score of 720 will save $125,755 more in interest than the person with a 580 credit score.

Let’s look at one more example. If you have a credit score of 720 and you want a personal loan for $8,500 for 5 years, you might qualify for an interest rate of 8%. If you have a credit score of 580, you might qualify for an interest rate of 27.9%. Over the life of the loan, a person with a credit score of 720 will pay $5,537 less interest than a person with a credit score of 580.

The total difference on these three loans is $140,667. If a person purchased and financed five cars in their lifetime, that amount increases to $178,167.

In short, your credit score has a significant impact on your financial life. The lower your credit score, the more interest you will pay for credit. This means there will be less money for you to put towards your goals.

If you have a credit score of 580 or less, you are not sentenced to a life of high interest. You can legitimately improve your credit score in a number of ways. The most important thing you can do is to learn what you need to know to make positive changes—that’s where an effective financial literacy course such as this one can help. You can also raise your credit score by:

• Paying your bills on time every month.
• Paying down your debt.
• Keeping your debts from going into collections.
• Not applying for too much credit.

Improving your credit score takes time and commitment, but it is possible to do it on your own. This means that it isn’t wise to go to a business and pay a high fee to have them clean up your credit report. If the information contained in your credit report is true, it will remain on your credit report for a specified period of time. If there is incorrect information on your report, you can work to get it removed yourself by filing a dispute.

Flo’s story demonstrates how a commitment to change and learning what you need to know can significantly impact your credit score. Flo, a single parent supporting herself and her son, had little experience in handling her personal finances. Due to a number of difficult and complex problems, Flo had not filed her taxes in a few years and had fallen behind on paying many of her bills. Tired of worrying about her financial situation, Flo decided to make an appointment with a credit counselor.

The first time Flo came to see her credit counselor, Kristen, her credit score was under 500. With Kristen’s help, Flo got in touch with someone to help her file her taxes. The next thing Flo did was to enroll in a financial literacy program to learn the skills she needed to handle her finances. Upon completing the program, Flo was ready to develop a plan to apply what she had learned. She cleared up unresolved problems, began paying her bills on time and in full, and finally felt the confidence she needed to meet her financial situation head-on.

Just one year later, Flo’s credit score had increased to over 700. Flo’s counselor, Kristen, credits the increase to the knowledge Flo gained from the financial education program she had completed and to her willingness to apply what she learned.

Learning what you need to know not only helps to increase your credit score, but can also save you thousands of dollars. Chapter 6 discusses what you need to know before signing a contract.

Chapter Review

• There are three national credit bureaus: Experian, Equifax, and Trans Union. They maintain a credit file on you. Most banks, credit unions, finance companies, and mortgage lenders report to the credit bureaus.
• Your credit score is an important number. The higher your credit score, the better credit risk you are considered and the better rate of interest you will be offered when using credit.
• You can do things to increase your credit score. Pay your bills on time, make full payments when they are due, pay down your debt, don’t let your accounts go into collections, and avoid applying for too much credit.