Your Credit Score Determines What You Pay
Ever wonder how a lender decides whether to grant you credit? Creditors use credit scoring systems to determine if you’d be a good risk for credit cards, auto loans, mortgages, and insurance. A higher credit score means you are likely to be a good risk, which, in turn, means you will be more likely to get credit or insurance – or pay less for it.
What is Credit Scoring?
Credit scoring is a system that creditors use to help determine whether to give you credit. It also may be used to help decide the terms you are offered or the rate you will pay for the loan.
Information about you and your credit experiences, like your bill-paying history, the number and type of accounts you have, whether you pay your bills by the date they are due, collection actions, outstanding debt and the age of your accounts, is collected from your credit report. Using a statistical program, creditors compare this information to the loan repayment history of consumers with similar profiles.
Credit Scores and Credit Reports
Your credit report is a key part of many credit scoring systems. That’s why it is critical to make sure your credit report is accurate. Federal law gives you the right to get a free copy of your credit reports from each of the three national credit reporting companies once every 12 months.
The Fair Credit Reporting Act (FCRA) also gives you the right to get your credit score from the national credit reporting companies. They are allowed to charge a reasonable fee for the score. When you buy your score, you often get information on how you can improve it.
To order your free annual credit report from one or all of the national credit reporting companies, and to purchase your credit score, visit www.annualcreditreport.com
How is a Credit Scoring System Developed?
To develop a credit scoring system or model, a creditor or insurance company selects a random sample of customers and analyzes it statistically to identify characteristics that relate to risk. Each of the characteristics then is assigned a weight based on how strong a predictor it is of who would be a good risk. Each company may use its own scoring model, different scoring models for different types of credit or insurance, or a generic model developed by a scoring company.
Under the Equal Credit Opportunity Act (ECOA), a creditor’s scoring system may not use certain characteristics—for example, race, sex, marital status, national origin, or religion—as factors. The law allows creditors to use age, but any credit scoring system that includes age must give equal treatment to applicants who are elderly.
What Can You Do to Improve Your Credit Score?
Credit scoring systems are complex and vary among creditors or insurance companies and for different types of credit or insurance. If one factor changes, your score may change; but improvement generally depends on how that factor relates to others the system considers. Scoring models usually consider the following types of information in your credit report to compute your credit score:
- Have you paid your bills on time? You can count on payment history to be a significant factor.
- Are you maxed out? Many scoring systems evaluate the amount of debt you have compared to your credit limits.
- How long have you had credit? Generally, scoring systems consider the length of your credit track record.
- Have you applied for new credit lately? Many scoring systems consider whether you have applied for credit recently by looking at “inquiries” on your credit report. Applying for too many new accounts in the recent past could have a negative effect on your score.
- How many credit accounts do you have and what kinds of accounts are they? Although it is generally considered a plus to have established credit accounts, too many credit cards may have a negative effect on your score.
Scoring models may be based on more than the information in your credit report. When you are applying for a mortgage loan, for example, the system may consider the amount of your down payment, your total debt, and your income, among other things.
Improving your score significantly is likely to take some time, but it can be done. To improve your credit score under most systems, focus on paying your bills in a timely way, paying down any outstanding balances, and staying away from new debt.
Article adapted from the Federal Trade Commission publication of the same title: www.ftc.gov/bcp/edu/pubs/consumer/credit/cre24.shtm
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For more information and financial guidance, please call TrueNorth at 1-800-798-4080. Our financial advisors would be happy to schedule a consultation with you and your loved ones to make sure the things that matter most are protected and accounted for. Visit the Financial Planning section of our website for more information.