Keeping Score: Reading Your Credit Report

Your credit score is a snapshot of your financial health.

Good credit, bad credit, no credit—we crave the first, cringe at the second, and are eager to fix the third. You probably have a general idea about how your credit score can impact your life (a high score means you can buy a house), how to interpret a credit score (a higher number is good, a lower number is bad), and how to maintain a solid score (make your payments on time).

To reach and maintain the holy grail of a high credit score—generally in the mid- to high 700s—it’s important to understand how the scores are calculated and what you can do to raise your score.

The history of the credit score

Before the creation of standardized credit scores, different lenders developed their own independent scoring systems. These scores, however, differed drastically from one another, making it difficult to understand what a number really meant. Then, in the 1950s, Fair, Isaac and Company—now FICO—set up the first credit-scoring system, with the range of 300 to 850. Known as the FICO score, it has become the score and algorithm most widely used by the largest credit-reporting agencies in the United States.

The exact formulas for calculating credit scores are basically secret, but five elements of differing weight make up a final score: payment history (35 percent), credit utilization (30 percent), length of credit history (15 percent), types of credit used (10 percent), and recent searches for credit (10 percent).

Who controls my financial life?

The three major credit-reporting agencies are Equifax, Experian, and TransUnion. Although they all use the FICO scoring model, your scores from these agencies can vary dramatically, because one agency might not have the same information about you as another agency. Therefore, it’s crucial to make sure that all three agencies have accurate information. In accordance with government law, you can obtain your complete credit report for free once every 12 months (available at annualcreditreport.com). The report contains the information from the three reporting agencies, so you can check for major discrepancies. Beyond accessing your free annual report, you can track your score using a free credit-score website (see box on page 51). If you have verified that the information on your complete credit report is correct, your credit scores should be the same.

A common misconception revolves around the myth that checking your credit score will automatically cause it to take a hit. That’s not completely accurate. There are two types of inquiry. One is the soft inquiry, which does not take points off your score. This inquiry, made for informational purposes, is most common when you use a website to get your credit score.

Hard inquiries are made by lenders, landlords, credit card providers, service providers, and insurance companies. Too many hard inquires can negatively impact your credit score, as they can be a warning sign that you want more credit than you have and are going to multiple lenders because you are being turned down. Although having your score dinged by a few points doesn’t sound appealing, hard inquires will fall off your report within a few years. The key is to avoid multiple hard inquiries within a short period of time.

“Hard inquiries will be necessary for everyone at some point,” says Ezra Fox, a writer for creditkarma.com. “It’s just important to do your due diligence and not apply for credit when you don’t need it.”

What the heck does that number mean?

So you’ve received your credit report and you are satisfied that the number is accurate. The next step is figuring out what that number means.

Let’s start with a perfect score: 850. We would all like to be the picture of perfection, but according to FICO, only about 0.5 percent of Americans ever reach the 850 mark. Because FICO does not divulge exactly how many points you will gain or lose for things like taking out a loan or missing a credit card payment, even achieving a score above 800 isn’t easy. That said, a score above 720 is very good and will generally allow you to get the best rates possible.

The average score in the United States is around 680, so a score between 680 and 719 generally means you’re in good shape. The 620 to 679 range starts to make life a little trickier, as you may face higher interest rates than if you had a solid score. A score below 620 is considered “subprime,” and most lenders won’t extend credit to those in this range because the risk appears too great.

“Your credit score is like your personal reputation,” says Fox. “And because there seem to be so many pitfalls, it makes sense that people worry about their score so much.”

One of the most common misconceptions is that if you have no debt, your credit score will automatically be high. Although having no debt is indeed important, having credit card bills that you pay off regularly is even more important. In the same way that you trust a good friend rather than a complete stranger with your money, credit bureaus can’t actively know you are trustworthy unless you develop a positive reputation.

“People will say, ‘I’ve never opened a credit card and I have no debt, so why is my score terrible?’” says Fox. “Well, if you have no history, then credit bureaus don’t know how to judge you, and they don’t know how much they can trust you when it comes to paying off your bills.”

A serious hit to your credit score can be troubling, but it’s not the end of the world. Eric Egan, a relationship manager with Wells Fargo, says that even if you have a major blemish, it’s fixable over time, so look forward, not backward.
“Credit may take some time to repair, but it is always worth trying to improve in the long run,” says Egan. “Focus should always be on improving your credit position for the future.”

There is still hope!

Being dragged down by poor credit is something that should be avoided, if possible. As Fox notes, “It’s always easier to bring your credit score down than it is to bring it back up.” If you are encountering difficulties with your credit, there are ways to get your score back on track, such as keeping the balances on your credit cards low, applying for new credit accounts only as needed, and paying off debt rather than moving it around. The simplest advice is always to make payments on time and in full, if possible. Remember that perfect credit is not just about owing no money. It also shows that you’re reliable at paying it back when credit is extended to you. “What occurred in the past is done and has already impacted your credit score,” says Egan. “Although it takes seven years for something to fully fall off your rolling credit history, just one or two years of improved credit history can have a dramatic impact on your credit score and, ultimately, what you can qualify for.”

Also remember that how your credit score is trending can be more important than the actual number, particularly if your score is above average.

“A small drop is not necessarily a problem,” says Fox. “But if month after month your score continues to drop without recovering, that’s a red flag.”

If you have impaired credit, you may not be able to get the best rates or structure. As a result, you may have to accept that what you want could cost you more for some period of time in having to pay higher interest rates or having to pay cash.
The world of credit can be tricky to navigate. The key is responsibility. Bad credit can set you back, but a good score can provide new opportunities.

“You never know when you are going to need to use your credit. It’s best to maintain a stellar credit rating so that you can buy that house or car or get that private loan,” says Egan. “Having good credit will correlate to having a more successful and stress-free lifestyle.” DW

Eddie Lee is DW’s assistant editor.

Credit Resources
annualcreditreport.com
Operated jointly by the three nationwide consumer credit-reporting companies: Equifax, Experian, and TransUnion. This is the site where you can request your complete credit report for free once every 12 months and is the only government-authorized source for your free annual credit report.
quizzle.com
Offers a free credit score as well as credit-monitoring services and recommendations for home loans.
creditsesame.com
Provides a filter to help you find the credit card that fits your needs based on your credit score, your monthly purchases, and other factors.
myfico.com
For a monthly fee, myFICO provides your score directly from FICO, in addition to numerous other credit information products.

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