Your credit score is a representation of your credit report and payment history. Every time you apply for a loan, use a credit card, miss a payment, or go over your credit limit, a report is generated by that action to one of the credit bureaus. It includes a record of your on-time and late payments, past and present credit accounts, accounts charged off, or accounts referred to collection agencies, negative entries over the last seven years, bankruptcies over the last 10 years, public records. Your credit action is factored into a formula that generates your credit score.
There are three credit bureas, Experian, Equifax, and Transunion. They are independent agencies and your information will not be indentical with each one. They monitor your payment activity, record your payment history, and give you a credit score that they sell to other institutions.
A score above 760 indicates very good to excellent credit, and should be the score to aim for. A high credit score will save you money with better loan offers with lower interest rates. If you have a low credit score, you will be charged high interest rates for all loans and credit cards. If your credit score drops, credit issuers may increase your interest rates, even if you still pay on time.
If the error is a late payment or billing issue, you can contact the creditor directly. You must be able to provide the paperwork to support your claim. They should report the correction to the credit bureaus, but it is a good idea to follow-up to make sure it has been reported and corrected.
Your credit score also determines your credit limit. The lower your score, the lower your limit will be. If your score is less than 650, expect your credit limit to be less than $1,000. It it is less than 600-500, expect a low credit of $200-$300 (if you are approved).
Example Showing the Effect of Credit Scores
Here is an example from FICO showing the affect of credit scores on interest rates on a $216,000 30-year fixed mortgage. The lowest score pays $227 more per month than the highest score.
It is very important that you check your credit score with all three credit bureaus at least once a year. It is possible that there are errors or closed accounts still lingering on your report. An error on your report could hurt your score and cost you money. Your score is continually updated and may fluctuate a few points each month. The credit bureaus will charge a fee for each report. The credit bureaus are: Experian (800-Experian), Equifax (800-686-1111), and TransUnion (800-916-8800).
You can get a free annual credit report from https://www.annualcreditreport.com/cra/index.jsp. This is the only place to get a free credit report. Beware of advertisements with a promise of a free credit report because it may be a scam.
Reasons for a Bad Credit Score
- Amount owed is too high.
- Too many accounts with a balance.
- Ratio of balances to credit limits on revolving accounts is too high. A high debt ratio indicates a higher risk of default on one of your loans.
- Length of time accounts have been established is too short.
- Number of accounts with delinquencies is too high. Serious delinquencies stay on your record for 7 years.
- Filing bankruptcy. This stays on your record for 7-10 years. If possible, avoid bankruptcy.
Limit your response to credit card offers. Each time you apply for a card or loan, the credit card issuer pulls a copy of your credit report, even if you don’t get the card. Just responding to the offer shows up on your credit history. This activity is a red flag for creditors if there are more than 4-5 of these during a six-month period. However, your score is not affected by multiple inquiries for auto loans or mortgages during a short time period. These are usually treated as a single inquiry.
Hard Inquiries vs. Soft Inquiries
Tips for a Good Credit Score
- Pay down your credit cards and close newer accounts that you don’t use and will not use in the future. It is a good idea to maintain your oldest accounts because longevity with these long-standing accounts looks good on a credit report. If these cards don’t have a good rate, contact the issuer and request a lower rate.
- Keep your debt-equity ratio under 30%.
- Use your credit card regularly and pay it off each month.
- Keep your bank record clean; an insufficient funds problem with your bank could show up on your credit report.
- If you have a good credit card, keep it. Maintaining a card and building a good payment history helps build your credit score. Creditors want you to have a long, dependable credit history.
- If you are just getting started, don’t open a lot of new accounts all at once because they will lower your average account age. Fast account buildup looks risky if you don’t have an established history.
Fixing your Credit Report
It is not uncommon to have an error in your credit report. It is up to you to monitor your report and dispute the errors. Errors in your credit report can result in a lower score, higher rates and penalties and fees.
Here are areas to look for errors in your credit report:
- Personal information that is misspelled or incorrect
- Someone else’s information who has a simliar name or Social Security Number
- Incorrect balances or incorrect amounts owed
- Closed credit accounts that are still listed as open
- Accounts that are not yours
- Balances owed or payments that are incorrect
If you find an error on your credit report, contact the credit bureau to report it. They must respond to your claim in thirty days or remove the information that is incorrect or can’t be verified. You can make your dispute by mail, telephone, or online. Disputing an item on your credit report will take some persistance and record keeping. It is a good idea to mail in the explanation of your situation and a copy of the credit report with the error. Keep copies for yourself. Keep a record of the details of any phone conversation.