Welcome to Day 5 of our 30-Day Easy Money Makeover! Every day in April, we're bringing you strategies to help you improve, and feel more confident about, your money situation. Follow along and see the rest of the calendar here.
It's just a three-digit number, but it could stand between you and the house or the car you want. So learn about your credit score before you need it. We give you the basics (and not so basics):
1. What is a credit score?
It's an algorithmically generated number that aims to help lenders predict the likelihood that a consumer will repay a loan. The score is based on numerous factors, such as a consumer’s record of repaying loans on time and the age of their accounts in good standing. The actual algorithm is proprietary information―a secret.
2. How is it different from a credit report?
Many people confuse the two, or use these terms interchangeably, but scores and reports are very different. A credit report attempts to log details on every credit-based financial transaction you make; a score rolls all that information into one number used to predict creditworthiness.
Score expert John Ulzheimer often says credit reports are like a test you took and scores are like the grade you got on that test. (That’s why we had you look over your credit report for errors and fraud on Day 4 of the money makeover.)
3. So, what’s my credit score?
Sorry, but you don’t have “a” credit score―you have many. Most consumers have dozens, if not hundreds, of scores, which will usually be in the same range.
Why so many? A multitude of lenders get scores from either FICO or VantageScore, but there are other brands. And any of those can be based on information from your credit reports at TransUnion, Equifax, or Experian. Meanwhile, say, FICO doesn't just generate one score for a consumer, it has several. There are scores designed for auto lenders, for example.
Also, scores change constantly, as bills are paid and loans are made. So a credit score is more of a snapshot than a definitive rating.
4. How do I see my scores?
Your credit score is not on your credit report, but you can see your score, sort of. Plenty of credit card companies and other financial institutions offer free scores monthly. Consumers can also get free scores from websites like Credit.com or CreditKarma.com, and can pay for their score from other outlets.
But know that many scores should be considered "educational," and they are not the same score a lender would see. If a lender denies you a loan because of a score, they must provide a "notice of adverse action," which reveals the precise score used.
Even if the score you can see is different than what a bank sees, it’s still valuable information―it lets you know how banks see you. Also, a sudden drop in your score can be a warning that you’ve been a victim of ID theft.
5. What’s a good score?
With a basic FICO score, the range is 300-850, although industry-specific scores can range even broader, from 250-900. (VantageScore now uses the same scale as FICO; previously, it used a range from 501-990.)
The average FICO score was 704 at the end of 2018, according to FICO. About 45% of Americans have scores of 740 or higher, considered very good to exceptional, according to credit bureau Experian. That group would probably qualify for a lender's best rate.
Another 16% have scores below 580, considered "very bad" by Experian and a high risk by lenders. They are more likely to be denied new credit.
In between are consumers who are often granted loans, but at higher interest rates than the preferred group.
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6. How do I get a good credit score?
Pay your bills on time, and you'll have a score good enough to get loans that your income supports. FICO, the largest scoring company, uses five criteria in its model: 35% is payment history; 30% is “amounts owed,” which for most people means how close they are to maxing out their credit cards; 15% is length of credit history; 10% is credit mix; and 10% is new credit (your score goes down a little each time you open a new account).
A note to those perfectionists out there. There’s no reason to fret over a score that’s lingering in the high 700s, or experiences a small drop. All you need is a score high enough to get a lender’s best rate. After that you are just being compulsive.
7. How much does it hurt to miss a payment?
A lot. And the higher your score, the greater the punishment for a missed payment. FICO says a consumer with a 780 score would see that drop to between 670 and 690 after being reported 30 days late on a mortgage, and the score wouldn’t recover to 780 for three years, all other things being equal. A consumer with a 680 score, however, would drop to 600-620 but would recover in nine months.
And this is why ID theft is such a big deal. Last year I wrote about an ID theft victim hit by a criminal who opened a DirecTV account in his name, then left him with a $615 unpaid bill. That one black mark knocked his once-stellar credit score down nearly 150 points.
That hits home the importance of regularly checking in on your credit reports and scores, especially ahead of a big move like buying a home. You want time to make sure your credit profile is in top financial shape.
April 5, 2019