What's Your Credit Karma?
It's more popular than a report card and has more impact on your life than your GPA ever will. It's your credit score -- the closest thing to a financial report card there is. Here's what it is and why it matters.
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Are you a 768? An 820? A 362 (gasp!)? A short time ago, you would have had no way to answer the ever-elusive question (and painfully unpopular pick-up line): "So, what's your credit score?"
Your credit score used to be a top-secret number known only to lending professionals. In March of 2001, the veil of credit-scoring secrecy was lifted. Now with just a click, you can see the three magic digits -- based on a formula developed by Fair, Isaac & Co. (FICO) or a handful of other credit reporting agencies -- that define your credit-worthiness. In FICOland, your number can range from 300 to 850. Anything above 720 is considered average.
Ho-hum. Big deal.
Well, it might be a big deal for you. The lending industry uses your credit score for a quick, objective assessment of consumer credit risk. (That's "credit trustworthiness," or "credit karma," in plain Fool-speak.) In some instances, this single measure can determine your fate in important matters -- whether you get a loan for that new home or car and at what interest rate, or if you qualify for the Puppy Palace Angora Visa for 10% off your first Bijon Frisse. For others, it matters not a bit. (For now, at least.)
The higher the score, the better the chance your request will be approved. According to Fair, Isaac, the FICO score is used in 75% of residential mortgage applications.
Credit score vs. credit report
Your credit score is simply a snapshot of your credit use -- it's the Cliffs Notes version of seven years of your borrowing history. In many lending situations (such as when you apply for that Angora Visa card), the lender bases its decision almost solely on your credit score. (Most use the score calculated by Fair, Isaac, the most popular of the credit scorers.) Consider your credit score the overall GPA of your borrowing history.
Your credit report is the detailed rundown of your borrowing habits. Credit reports are provided by three major credit bureaus: Equifax, Experian, and TransUnion. The information in each is used to calculate your overall credit GPA (credit score). Most lenders don't care about the details of your credit report. They just want your overall score. However, you should care about your report. If you want to raise your overall credit GPA, you'll need to use your credit reports (all three) to get to the bottom of the problem.
Your credit report card
Credit-reporting agencies keep tabs on various accounts -- past and present -- opened in your name, including credit cards, bank credit lines, mortgages, department store charge cards, and other bills (though usually not rent payments or utilities).
Your credit report also includes any collection actions taken against you and any public-record information that may exist, such as liens or bankruptcy proceedings, or how often you floss and if you returned that book of Poe poems you checked out in the third grade. (Okay, we're exaggerating a little bit on those last few.)
In general, reported data falls into four categories:
- Personal information -- Past home addresses and some employment history, in addition to the obvious stuff like name, address, and Social Security number.
- Credit history -- Open credit lines and installment loans, plus a record of all late payments (30 days or more) to anyone -- from phone company to mortgage holder.
- Public records -- Bankruptcies and other court judgments, like alimony agreements and tax liens.
- Inquiries -- A dated listing of all recent business requests to see your file. Requests by you to see your own credit file are not recorded or counted.
Whenever you apply for a loan, or even at other times, the lender requests a copy of your credit report from one of the three major credit-reporting agencies. Based on that, your credit score is calculated. Again, your overall score weighs heavily in a lender's decision. Though depending on the type of credit you are requesting, the lender may also look at your income, length of employment, and if your shoes match.
To make things confusing (shocker, we know), the three credit bureaus don't necessarily have the same information (and don't necessarily all use the FICO method). So depending on which reporting agency your lender uses, your credit score might be different.
Whatever judgment is passed down upon you by The Great and Wise Credit Scorers, take comfort in the fact that you have unprecedented access to their oracle and have the power to change your score.
Six Tips for Establishing Good Credit
Even if you're a confirmed rebel, try to be as "normal" as possible in your consumer credit habits, especially if you expect to borrow for a house some day. Instead, channel all your anti-establishment efforts towards clothes, music, and body piercings. Here are six small ways to keep your credit record clean:
- Pay your bills on time, especially mortgage or rent payments. Apart from extreme circumstances like bankruptcy or tax liens, nothing has as big of an impact on your credit history as late payments.
- Establish credit early. Having clean, active charge accounts established many years ago will boost your score. If you are averse to credit, on principle, consider setting up automatic monthly payments for, say, utilities and phone on a credit card account and locking the card away where it's not a temptation.
- Don't max out available credit on credit card accounts. Lenders won't be impressed. Instead, they are much more likely to assume that you have trouble managing your finances. Beyond one or two credit cards, it starts to get complicated.
- Don't apply for too much credit in a short amount of time. Multiple requests for your credit history (not including requests by you to check your file) will reduce your score. If you are hunting around for good loan rates, assume that every time you give your Social Security number to a lender or credit card company, they will order a credit history.
- Be neat and consistent when filling out credit applications. This will insure that all your good deeds get recorded in a single file, as opposed to multiple files or, worse, someone else's file. Watch out for inconsistencies in use of "Jr." and "Sr." If it gets ugly, remind dad that he already has his house.
- Check your credit history for errors, especially if you will soon be requesting a time-dependent loan, like a mortgage.
Next up: How Lenders Keep Score