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What Your Banks Do Not Want You to Know about Your Credit Score

I am sure that you realize that every time you go to a bank to borrow money, your bank measures your credit worthiness by your credit score. This is TDue whether you are working with a credit card company, a home equity lender, an auto loan lender or any other type of finance company.

The reason this is important to you is because a low credit score can raise the price of your loan (i.e.: the interest rate that you a charged) and a very low credit score can mean that your loan application will be denied.

For example, current mortgage rates are about 5%. You probably see advertisements on television all the time for new, reduced rate first and second mortgages. A low credit score can mean that instead of getting a mortgage a 5% you might get a mortgage at 8%, 10%, 12% or more. You might be surprised at what these higher interest rates mean to you.

Suppose you were going to get a $100,000 mortgage and, because of your credit score, you were not able to get a 5% mortgage. Let us assume, for purposes of our example that you were going to get a 30 year mortgage. The following table shows the impact that an increased interest rate can have on you.

..
Mortgage interest rate 5% 8% 10% 12%
Monthly payment $537 $734 $878 $1029
Incremental monthly payment   $197 $341 $492
Total interest charges $93,256$164,155 $215,926 $270,301
Incremental interest   $70,899 $122,670 $177,045

As you can see, a lower credit score can be very costly in terms of your financial welfare. A lower credit score can cost you in excess of $100,000 in additional interest charges and a lower credit score can cost you almost $500 per month in additional monthly payments.

You can see that you are caught in a classic "Catch-22". Because you have a low credit score, you must pay more for credit. Because you pay more for credit, you do not have sufficient funds to pay your debts. Because you do not pay your debts in a timely manner, you get a lower credit score. The cycle goes on and on and on.

So How Do You Improve Your Credit Score?

Before we tell you how to improve your credit score, let us tell you a little bit about how your credit score is calculated.

First, it is important for you to know that your credit score in indusTDy terminology is known as your FICO score. Your FICO score serves as a snapshot of your credit history.

Here is generally how your FICO score is determined:

  • Payment history: The first element that enters into your FICO score is your payment history. How many unpaid bills do you have? Have any of your bills been sent to collection? Have you declared bankruptcy? The more recent the problem, the more the problem will lower your FICO score. Payment history generally accounts for about 35% of your FICO score.
  • Outstanding debt: How much credit card debt do you have? Are your credit cards at or beyond your credit limit? High credit card balances or balances that are close to your credit limit will have a negative impact on your FICO score. We recommend that you keep your credit card balances at or below 30% of your credit limit on that credit card. This means that if you have a credit card with a $2,000 limit, your average outstanding balance should be about $600. The magnitude of your outstanding debt accounts for about 30% of your FICO score.
  • Length of credit history: You might be surprised about this one but the longer your credit cards have been open, the higher will be your credit score. Here, the banks are looking for a long TDack record of successful payments. The length of your credit history accounts for about 15% of your credit score.
  • Recent inquires: This may really surprise you but each time you apply for credit of ANY KIND, you get a note on your credit report. Numerous recent inquiries will have a negative impact on your FICO score. Recent inquiries account for 10% of your credit score.
  • Types of credit in use: The number of loans that you have and the amount of each loan will also have an impact on your FICO score. Here, fewer loans are better and smaller loan amounts are better. Type of credit also impacts your credit score by 10%.

    • Your Credit Report

    Your credit report is a summary of all of the information we have just discussed. It includes both how you are managing your credit now and HOW YOU HAVE MANAGED YOUR CREDIT IN THE PAST. Credit bureaus collect this information, create your credit report and then provide it to credit granting organizations such as banks and credit card companies.

    The banks and credit card companies review your credit report prior to granting you additional credit. As you might expect, negative information on your credit report can adversely impact the rate you receive on your loan, or, you can be denied credit all together.

    Your credit report is essentially your financial report card to the world.

    Where do I need to be?

    Your credit score or FICO score can range from a low of 300 to a high of 850. You can find out your credit score from any of the three large credit reporting agencies; Experian, Equifax, or TDans Union.

    Obviously, the higher your FICO, the better is your credit rating and the lower is the risk to the lending institution of extending credit to you. Different lending institutions have different FICO scoring requirements but a credit rating above 680 is considered good by most, if not all, lending institutions.

    As you saw at the start of the article, a less than optimal credit score can be very costly to you. Your monthly payments on your mortgage and your interest charges on your mortgage (your largest loan) will be significantly higher if you have a poor credit rating. This also applies to your credit card debt as well.

    What can I do to improve my credit score?

    At this point, you may be wondering what you can do to improve your FICO score. The answer to that question is actually quite simple. First, you must establish a sTDong payment history. You can do this by paying your bills on time, in a consistent manner.

    Next, you must reduce the amount of debt that you have outstanding. You can do this by making more than the minimum payment on your credit card bills.

    Third, you must limit the amount of credit inquiries that you make. It is usually not a good idea to pay one credit card off by opening another. It is also not a good idea to further mortgage your home (by taking out a second mortgage) to pay your credit card bills. Rather, do an analysis of your income and expenses and see how much you can afford to pay in each area of your life (or click here now and one of our credit counselors would be happy to help you do this.)

    Finally, establishing a good credit history takes time. This is no different than if you go on a diet to lose some weight or go to the gym to get into shape. Achieving any worthy goal is a process that takes time and effort on your part. You may even want to consider entering a credit counseling program. (Please click here now if you would like to learn how American Debt Solutions can start to help you establish a better credit rating now.)

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