May 20, 2005
How your Credit Score Works and How it is Calculated
What Lenders Want to See
How to impress lenders
Make the most of your credit reports, what hurts your credit score -- and how to improve it.
By Jonah Freedman, MONEY Magazine
NEW YORK (MONEY Magazine) - Evan Hendricks wants to arm you with knowledge. His exhaustive Credit Scores and Credit Reports is a new, plain- English guide to what consumers need to know about this arcane topic, a strange universe filled with pitfalls and fine print that makes the tax code read like Dr. Seuss.
As the book makes clear, it's a subject we ignore at our peril: Credit scoring is more than ever having a serious effect on all our lives.
So we asked Hendricks for tips on improving and protecting our credit status, plus how best to take advantage of the new Fair and Accurate Credit Transactions Act (FACTA), which is being touted as the best tool in a long time for those who are using credit but are anxious about identity theft.
Q. Is FACTA all that important? Will it make a big difference to most people?
A. It's a big deal. The first thing this law does is give everyone the right to free credit reports. There's also a requirement that when you apply for a mortgage, the lender must give you your credit score and show you the report it's based on. And it beefs up the system of fraud alerts to help protect against identity theft.
Q. What should you do with your free credit reports?
A. Checking that your credit report doesn't include any credit cards or loans that you didn't apply for is the best tool you've got against ID theft. Also, checking your report helps to make sure that your credit score is being calculated on the basis of accurate information. And that matters: The lower your score, the more you pay for a loan.
Q. Can you clarify those terms? What's the difference between a credit report and a credit score?
A. Your credit report is a detailed dossier of your whole financial life. It lists all your open credit lines and shows who has looked at your credit report and for what reasons. The credit score is an assessment of your creditworthiness boiled down to a single number that lets potential creditors make a quick judgment on you.
Q. Do you have to check both?
A. Focus on your credit report, which you should check three or four times a year because the information can change constantly. Once a year isn't enough anymore -- but doing it once a year is better than doing it only every two years. FACTA created a centralized source (annualcreditreport.com) to get one free report per year from each of the major credit bureaus. So far, only residents of the western states are eligible. Midwestern states will be eligible on March 1, southern states on June 1, and eastern states on Sept. 1. You can elect to get one, two or all three reports at once. The best way to monitor your credit is to stagger your requests and get one report every four months.
The site started operating in December, so there are still a few glitches. It's going to take some patience. But with these free reports, there's no excuse not to become more involved with your credit reports.
Q. What do you do if you see a mistake?
A. Dispute it. There's a form attached to your report - - use that, and then you can also attach a very concise letter to explain your case, plus any supporting documentation. Send it to the credit bureau by registered mail and request proof of receipt.
Once they receive it, they have 30 days either to verify that what's on there belongs there or to remove the item from your report. If you don't hear from them in about 40 days, you win by default. Write another letter saying, "Thank you for agreeing to delete that item, pursuant to the law." One shortcut is to get the creditor to provide a letter saying you're right and this no longer belongs on your credit report. The bureaus will believe the creditor before they believe the consumer.
Sometimes it works the way it's supposed to. But I've seen cases where the only way people could get mistakes off their credit report was by filing a federal lawsuit.
Know the score
Q. And what about checking your credit score?
A. It's good to know where you stand, but you really only need to check it if you're planning on making a major financial transaction in the next 60 days: a home loan, a refi or an auto loan.
Make sure it's a so-called FICO score -- that's the one used by 75 percent of lenders. [It's a creation of the Fair Isaac Corp., and it's available at annualcreditreport.com for $7.]
Two of the major credit bureaus sell their own versions, but those are knockoffs. They're fine if you want a general idea of where you stand. But if you're getting ready to make that transaction, get your FICO score.
Q. What are some common missteps that bring down your score?
A. Balance transfers on your credit cards, for one thing. It may seem smart to load all your debt onto one low-rate card. But if you max out on a high-limit card, your credit score takes a big hit. Even if you aren't applying for more credit, your current credit- card companies may raise your interest rates because your credit score dropped.
The whole instant-credit thing also hurts your credit, like when you're at the Gap and they say you get 10 percent off if you apply for a credit card and buy this thing using your new credit card. You have the combined effect of an "inquiry for new credit" and a small credit limit on the store card, which you already filled up. Both are bad.
The other thing you have to watch out for are collections, the leading type of which is medical collection. Many of those are mistakes -- often an insurance company is responsible for a co-payment, but the doctor bills it to the patient and it ends up becoming a collection.
It's not your fault, but it will show up on your report and become bad news. Then you have to dispute it with the bureau, preferably with documentation from the doctor.
Q. Can you really improve your score?
A. Absolutely. But you can't do it instantly. It's like dieting: It takes patience and discipline. The first thing you can do is look at your balance/credit-limit ratio. The more you can do to get your balances down to less than 50 percent of your credit limit, the higher your score.
Then make sure the information on your report is accurate. Let's say you missed a 30-day payment deadline but your report has it down as 60 days late.
Fix it.
Q. I hear everyone looks at credit scores these days.
A. Yeah, anybody with a so-called permissible purpose, which has historically meant primarily creditors, insurers and employers. But we're seeing credit scores used for more and more purchases. Utilities and wireless-phone providers, for instance, are starting to get into it. Half the time, they don't even tell you they're running a check. And credit- card companies are getting prescreened lists from the bureaus.
Q. Is there any way to keep your name off some of these lists?
A. Yes. You can call 888-5-OPT-OUT. It's a joint entity operated by the three major credit bureaus.
Q. So given what you do for a living, you must have a perfect credit score, right?
A. It looks pretty good, but I have one 30-day and one 60-day late payment from 1999, both on a Sears account. I tried disputing them, but I didn't get anywhere, so I gave up -- it's old enough that it's not seriously impacting my credit.
How Credit Scores Work, How a Score Is Calculated
By PAT CURRY
Ever wonder why you can go online and be approved for credit within 60 seconds? Or get pre-qualified for a car without anyone even asking you how much money you make? Or why you get one interest rate on loans, while your neighbor gets another?
The answer is credit scoring.
Your credit score is a number generated by a mathematical algorithm -- a formula -- based on information in your credit report, compared to information on tens of millions of other people. The resulting number is a highly accurate prediction of how likely you are to pay your bills.
If it sounds arcane and unimportant, you couldn't be more wrong. Credit scores are used extensively, and if you've gotten a mortgage, a car loan, a credit card or auto insurance, the rate you received was directly related to your credit score. The higher the number, the better you look to lenders. People with the highest scores get the lowest interest rates.
Scoring categories:
The scale runs from 300 to 850. The vast majority of people will have scores between 600 and 800. A score of 720 or higher will get you the most favorable interest rates on a mortgage, according to data from Fair Isaac Corp., a California-based company that developed the credit score. (Its own score is called the FICO score.)
Fair Isaac reports that the American public's credit scores break out along these lines:
Credit score Percentage
499 and below 1 percent
500-549 5 percent
550-599 7 percent
600-649 11 percent
650-699 16 percent
700-749 20 percent
749-799 29 percent
800 and above 11 percent
What's the big deal?
Your credit score will determine if you get credit at all, and the interest rate on that credit, says Ed Ojdana, president of Experian Consumer Direct, part of Experian, the largest of the three major credit- reporting agencies. "The better the score, the lower the interest rate and that can save you a ton of money."
The difference in the interest rates offered to a person with a score of 520 and a person with a 720 score is 3.45 percentage points, according to Fair Isaac's Web site. On a $100,000, 30-year mortgage, that difference would cost more than $85,000 extra in interest charges, according to Bankrate.com's mortgage calculator. The difference in the monthly payment alone would be about $235
Powerful little number:
If you rented an apartment, got braces, bought cell phone service, applied for a job that involved handling a lot of money, or needed to get utilities connected, there's a good chance your score was pulled.
If you have an existing credit card, the issuer is likely to look at your credit score to decide whether to increase your credit line -- or charge you a higher interest rate, according to a credit scoring study by the Consumer Federation of America and the National Credit Reporting Association.
Buying a car? Most car dealers want to know your credit score when you walk in the door, says Bob Kurilko, vice president of marketing and industry communications for Edmunds.com, an online consumer resource for automotive issues. "They want to know how they can put a loan together for you."
The score has made it easier for many people to get credit, Kurilko says. Before, it was up to individual lending institutions to come up with their own criteria, he says. "They would hedge their risk and tend to go conservatively. It's opened up lending to a lot more people."
Consumers' rights:
Until recently, many Americans didn't even know this number existed because it was a closely guarded secret in the lending industry. In fact, lenders were prohibited from telling borrowers their credit score. The line of reasoning: The number was the result of analyzing complex financial data that the layperson would have difficulty understanding. Plus, if people knew their score (according to the industry mindset at the time), they might be able to change their behavior to manipulate the score and throw off the whole model, rendering it useless.
All that changed a few years ago, when consumers began finding out about the score and demanding to see it. In an unprecedented move in 2000, online lender E-Loan offered to give consumers their scores for free, with information explaining how the score is calculated and how they might improve it. Fair Isaac responded by cutting E-Loan off from its source of credit reports, effectively crippling its ability to lend money. E-Loan stopped giving away credit scores.
Public outcry on the possibility of people being denied credit based on bad information in credit reports led to several pieces of legislation -- and a much more open attitude about credit scores.
Fast forward to current day: Not only can consumers buy their score online from any number of sources, but they are now entitled to one free credit report per year. Consumers in western states can begin requesting their free annual credit report Dec. 1, but if you live on the East coast you'll have to wait until Sept. 1, 2005. To find out when you become eligible to receive a free credit report, check out Bankrate's map.
Key factors of your score
Just what goes into the score? Everything in your credit report, with different kinds of information carrying differing weights, says Fair Isaac consumer affairs manager Craig Watts. The model looks at more than 20 factors in five categories.
1. How you pay your bills (35 percent of the score)
The most important factor is how you've paid your bills in the past, placing the most emphasis on recent activity. Paying all your bills on time is good. Paying them late on a consistent basis is bad. Having accounts that were sent to collections is worse. Declaring bankruptcy is worst.
2. Amount of money you owe and the amount of available credit (30 percent)
The second most important area is your outstanding debt -- how much money you owe on credit cards, car loans, mortgages, home equity lines, etc. Also considered is the total amount of credit you have available. If you have 10 credit cards that each have $10,000 credit limits, that's $100,000 of available credit. Statistically, people who have a lot of credit available tend to use it, which makes them a less attractive credit risk.
"Carrying a lot of debt doesn't necessarily mean you'll have a lower score," Watts says. "It doesn't hurt as much as carrying close to the maximum. People who consistently max out their balances are perceived as riskier. People who never use their credit don't have a track history. People with the highest scores use credit sparingly and keep their balances low."
3. Length of credit history (15 percent)
The third factor is the length of your credit history. The longer you've had credit -- particularly if it's with the same credit issuers -- the more points you get.
4. Mix of credit (10 percent)
The best scores will have a mix of both revolving credit, such as credit cards, and installment credit, such as mortgages and car loans. "Statistically, consumers with a richer variety of experiences are better credit risks," Watts says. "They know how to handle money."
5. New credit applications (10 percent)
The final category is your interest in new credit -- how many credit applications you're filling out.
The model compensates for people who are rate shopping for the best mortgage or car loan rates. The only time shopping really hurts your score, Watts says, is when you have previous recent credit stumbles, such as late payments or bills sent to collections.
"Then, looking for new credit will be seen as an alarm because statistically, before people declare bankruptcy and default on everything, they look for a life preserver," Watts says. Also, if you have a very young credit file, an inquiry can count for more than if you've had credit for a long time.
What doesn't count in a score-The scoring model doesn't look at: - age
- race
- job or length of employment at your job
- income
- education
- marital status
- whether or not you've been turned down for credit
- length of time at your current address
- whether you own a home or rent
A lender may consider all those factors when deciding whether to approve a loan application, but they aren't part of how a FICO score is calculated, Watts says.
Credit scores are not perfect The major drawback to credit scoring is that it relies on information in your credit report, which is quite likely to contain errors. That's why it's critical that you check your credit reports annually, or at the very least three to six months before planning to buy a house or a car. That will give you sufficient time to correct any errors before a lender pulls your score.
Watts says that the need for accuracy in credit files is one reason why it's good for consumers to learn about credit scores. "There's a hope that as consumers know about credit reports and scores, they'll do more to correct errors and provide more oversight," he says. "If consumers can police the accuracy of their own reports, everybody gains."
Want to get an approximation of your score? Bankrate and FICO have teamed up to create the free FICO Score Estimator.
How to impress lenders
Make the most of your credit reports, what hurts your credit score -- and how to improve it.
By Jonah Freedman, MONEY Magazine
NEW YORK (MONEY Magazine) - Evan Hendricks wants to arm you with knowledge. His exhaustive Credit Scores and Credit Reports is a new, plain- English guide to what consumers need to know about this arcane topic, a strange universe filled with pitfalls and fine print that makes the tax code read like Dr. Seuss.
As the book makes clear, it's a subject we ignore at our peril: Credit scoring is more than ever having a serious effect on all our lives.
So we asked Hendricks for tips on improving and protecting our credit status, plus how best to take advantage of the new Fair and Accurate Credit Transactions Act (FACTA), which is being touted as the best tool in a long time for those who are using credit but are anxious about identity theft.
Q. Is FACTA all that important? Will it make a big difference to most people?
A. It's a big deal. The first thing this law does is give everyone the right to free credit reports. There's also a requirement that when you apply for a mortgage, the lender must give you your credit score and show you the report it's based on. And it beefs up the system of fraud alerts to help protect against identity theft.
Q. What should you do with your free credit reports?
A. Checking that your credit report doesn't include any credit cards or loans that you didn't apply for is the best tool you've got against ID theft. Also, checking your report helps to make sure that your credit score is being calculated on the basis of accurate information. And that matters: The lower your score, the more you pay for a loan.
Q. Can you clarify those terms? What's the difference between a credit report and a credit score?
A. Your credit report is a detailed dossier of your whole financial life. It lists all your open credit lines and shows who has looked at your credit report and for what reasons. The credit score is an assessment of your creditworthiness boiled down to a single number that lets potential creditors make a quick judgment on you.
Q. Do you have to check both?
A. Focus on your credit report, which you should check three or four times a year because the information can change constantly. Once a year isn't enough anymore -- but doing it once a year is better than doing it only every two years. FACTA created a centralized source (annualcreditreport.com) to get one free report per year from each of the major credit bureaus. So far, only residents of the western states are eligible. Midwestern states will be eligible on March 1, southern states on June 1, and eastern states on Sept. 1. You can elect to get one, two or all three reports at once. The best way to monitor your credit is to stagger your requests and get one report every four months.
The site started operating in December, so there are still a few glitches. It's going to take some patience. But with these free reports, there's no excuse not to become more involved with your credit reports.
Q. What do you do if you see a mistake?
A. Dispute it. There's a form attached to your report - - use that, and then you can also attach a very concise letter to explain your case, plus any supporting documentation. Send it to the credit bureau by registered mail and request proof of receipt.
Once they receive it, they have 30 days either to verify that what's on there belongs there or to remove the item from your report. If you don't hear from them in about 40 days, you win by default. Write another letter saying, "Thank you for agreeing to delete that item, pursuant to the law." One shortcut is to get the creditor to provide a letter saying you're right and this no longer belongs on your credit report. The bureaus will believe the creditor before they believe the consumer.
Sometimes it works the way it's supposed to. But I've seen cases where the only way people could get mistakes off their credit report was by filing a federal lawsuit.
Know the score
Q. And what about checking your credit score?
A. It's good to know where you stand, but you really only need to check it if you're planning on making a major financial transaction in the next 60 days: a home loan, a refi or an auto loan.
Make sure it's a so-called FICO score -- that's the one used by 75 percent of lenders. [It's a creation of the Fair Isaac Corp., and it's available at annualcreditreport.com for $7.]
Two of the major credit bureaus sell their own versions, but those are knockoffs. They're fine if you want a general idea of where you stand. But if you're getting ready to make that transaction, get your FICO score.
Q. What are some common missteps that bring down your score?
A. Balance transfers on your credit cards, for one thing. It may seem smart to load all your debt onto one low-rate card. But if you max out on a high-limit card, your credit score takes a big hit. Even if you aren't applying for more credit, your current credit- card companies may raise your interest rates because your credit score dropped.
The whole instant-credit thing also hurts your credit, like when you're at the Gap and they say you get 10 percent off if you apply for a credit card and buy this thing using your new credit card. You have the combined effect of an "inquiry for new credit" and a small credit limit on the store card, which you already filled up. Both are bad.
The other thing you have to watch out for are collections, the leading type of which is medical collection. Many of those are mistakes -- often an insurance company is responsible for a co-payment, but the doctor bills it to the patient and it ends up becoming a collection.
It's not your fault, but it will show up on your report and become bad news. Then you have to dispute it with the bureau, preferably with documentation from the doctor.
Q. Can you really improve your score?
A. Absolutely. But you can't do it instantly. It's like dieting: It takes patience and discipline. The first thing you can do is look at your balance/credit-limit ratio. The more you can do to get your balances down to less than 50 percent of your credit limit, the higher your score.
Then make sure the information on your report is accurate. Let's say you missed a 30-day payment deadline but your report has it down as 60 days late.
Fix it.
Q. I hear everyone looks at credit scores these days.
A. Yeah, anybody with a so-called permissible purpose, which has historically meant primarily creditors, insurers and employers. But we're seeing credit scores used for more and more purchases. Utilities and wireless-phone providers, for instance, are starting to get into it. Half the time, they don't even tell you they're running a check. And credit- card companies are getting prescreened lists from the bureaus.
Q. Is there any way to keep your name off some of these lists?
A. Yes. You can call 888-5-OPT-OUT. It's a joint entity operated by the three major credit bureaus.
Q. So given what you do for a living, you must have a perfect credit score, right?
A. It looks pretty good, but I have one 30-day and one 60-day late payment from 1999, both on a Sears account. I tried disputing them, but I didn't get anywhere, so I gave up -- it's old enough that it's not seriously impacting my credit.
How Credit Scores Work, How a Score Is Calculated
By PAT CURRY
Ever wonder why you can go online and be approved for credit within 60 seconds? Or get pre-qualified for a car without anyone even asking you how much money you make? Or why you get one interest rate on loans, while your neighbor gets another?
The answer is credit scoring.
Your credit score is a number generated by a mathematical algorithm -- a formula -- based on information in your credit report, compared to information on tens of millions of other people. The resulting number is a highly accurate prediction of how likely you are to pay your bills.
If it sounds arcane and unimportant, you couldn't be more wrong. Credit scores are used extensively, and if you've gotten a mortgage, a car loan, a credit card or auto insurance, the rate you received was directly related to your credit score. The higher the number, the better you look to lenders. People with the highest scores get the lowest interest rates.
Scoring categories:
The scale runs from 300 to 850. The vast majority of people will have scores between 600 and 800. A score of 720 or higher will get you the most favorable interest rates on a mortgage, according to data from Fair Isaac Corp., a California-based company that developed the credit score. (Its own score is called the FICO score.)
Fair Isaac reports that the American public's credit scores break out along these lines:
Credit score Percentage
499 and below 1 percent
500-549 5 percent
550-599 7 percent
600-649 11 percent
650-699 16 percent
700-749 20 percent
749-799 29 percent
800 and above 11 percent
What's the big deal?
Your credit score will determine if you get credit at all, and the interest rate on that credit, says Ed Ojdana, president of Experian Consumer Direct, part of Experian, the largest of the three major credit- reporting agencies. "The better the score, the lower the interest rate and that can save you a ton of money."
The difference in the interest rates offered to a person with a score of 520 and a person with a 720 score is 3.45 percentage points, according to Fair Isaac's Web site. On a $100,000, 30-year mortgage, that difference would cost more than $85,000 extra in interest charges, according to Bankrate.com's mortgage calculator. The difference in the monthly payment alone would be about $235
Powerful little number:
If you rented an apartment, got braces, bought cell phone service, applied for a job that involved handling a lot of money, or needed to get utilities connected, there's a good chance your score was pulled.
If you have an existing credit card, the issuer is likely to look at your credit score to decide whether to increase your credit line -- or charge you a higher interest rate, according to a credit scoring study by the Consumer Federation of America and the National Credit Reporting Association.
Buying a car? Most car dealers want to know your credit score when you walk in the door, says Bob Kurilko, vice president of marketing and industry communications for Edmunds.com, an online consumer resource for automotive issues. "They want to know how they can put a loan together for you."
The score has made it easier for many people to get credit, Kurilko says. Before, it was up to individual lending institutions to come up with their own criteria, he says. "They would hedge their risk and tend to go conservatively. It's opened up lending to a lot more people."
Consumers' rights:
Until recently, many Americans didn't even know this number existed because it was a closely guarded secret in the lending industry. In fact, lenders were prohibited from telling borrowers their credit score. The line of reasoning: The number was the result of analyzing complex financial data that the layperson would have difficulty understanding. Plus, if people knew their score (according to the industry mindset at the time), they might be able to change their behavior to manipulate the score and throw off the whole model, rendering it useless.
All that changed a few years ago, when consumers began finding out about the score and demanding to see it. In an unprecedented move in 2000, online lender E-Loan offered to give consumers their scores for free, with information explaining how the score is calculated and how they might improve it. Fair Isaac responded by cutting E-Loan off from its source of credit reports, effectively crippling its ability to lend money. E-Loan stopped giving away credit scores.
Public outcry on the possibility of people being denied credit based on bad information in credit reports led to several pieces of legislation -- and a much more open attitude about credit scores.
Fast forward to current day: Not only can consumers buy their score online from any number of sources, but they are now entitled to one free credit report per year. Consumers in western states can begin requesting their free annual credit report Dec. 1, but if you live on the East coast you'll have to wait until Sept. 1, 2005. To find out when you become eligible to receive a free credit report, check out Bankrate's map.
Key factors of your score
Just what goes into the score? Everything in your credit report, with different kinds of information carrying differing weights, says Fair Isaac consumer affairs manager Craig Watts. The model looks at more than 20 factors in five categories.
1. How you pay your bills (35 percent of the score)
The most important factor is how you've paid your bills in the past, placing the most emphasis on recent activity. Paying all your bills on time is good. Paying them late on a consistent basis is bad. Having accounts that were sent to collections is worse. Declaring bankruptcy is worst.
2. Amount of money you owe and the amount of available credit (30 percent)
The second most important area is your outstanding debt -- how much money you owe on credit cards, car loans, mortgages, home equity lines, etc. Also considered is the total amount of credit you have available. If you have 10 credit cards that each have $10,000 credit limits, that's $100,000 of available credit. Statistically, people who have a lot of credit available tend to use it, which makes them a less attractive credit risk.
"Carrying a lot of debt doesn't necessarily mean you'll have a lower score," Watts says. "It doesn't hurt as much as carrying close to the maximum. People who consistently max out their balances are perceived as riskier. People who never use their credit don't have a track history. People with the highest scores use credit sparingly and keep their balances low."
3. Length of credit history (15 percent)
The third factor is the length of your credit history. The longer you've had credit -- particularly if it's with the same credit issuers -- the more points you get.
4. Mix of credit (10 percent)
The best scores will have a mix of both revolving credit, such as credit cards, and installment credit, such as mortgages and car loans. "Statistically, consumers with a richer variety of experiences are better credit risks," Watts says. "They know how to handle money."
5. New credit applications (10 percent)
The final category is your interest in new credit -- how many credit applications you're filling out.
The model compensates for people who are rate shopping for the best mortgage or car loan rates. The only time shopping really hurts your score, Watts says, is when you have previous recent credit stumbles, such as late payments or bills sent to collections.
"Then, looking for new credit will be seen as an alarm because statistically, before people declare bankruptcy and default on everything, they look for a life preserver," Watts says. Also, if you have a very young credit file, an inquiry can count for more than if you've had credit for a long time.
What doesn't count in a score-The scoring model doesn't look at: - age
- race
- job or length of employment at your job
- income
- education
- marital status
- whether or not you've been turned down for credit
- length of time at your current address
- whether you own a home or rent
A lender may consider all those factors when deciding whether to approve a loan application, but they aren't part of how a FICO score is calculated, Watts says.
Credit scores are not perfect The major drawback to credit scoring is that it relies on information in your credit report, which is quite likely to contain errors. That's why it's critical that you check your credit reports annually, or at the very least three to six months before planning to buy a house or a car. That will give you sufficient time to correct any errors before a lender pulls your score.
Watts says that the need for accuracy in credit files is one reason why it's good for consumers to learn about credit scores. "There's a hope that as consumers know about credit reports and scores, they'll do more to correct errors and provide more oversight," he says. "If consumers can police the accuracy of their own reports, everybody gains."
Want to get an approximation of your score? Bankrate and FICO have teamed up to create the free FICO Score Estimator.
# posted by Sponduliqs @ 8:20 AM 
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