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Today, Mr Credit Card is going to give us a quick run down on credit bureaus and credit scores. Aside from reviewing credit cards, Mr Credit Card has also written about identity theft protection reviews. Please check out his site for the latest credit news
A couple of hundred years ago if you wanted a loan you might have to present your case to the lender for why you are “good for it”. If the lender didn’t know you, they might ask about you around town to see what your financial reputation was. Today, the Credit Agencies fill that role in an electronic way. Virtually all people in the United States have a file with Equifax, TransUnion, and Experian, the three major credit agencies. For a long time, the file consisted solely of the details of the accounts you hold with lenders that report to one of these agencies. For instance, your bank might report your credit card account, when it was opened, what your balance is, what your credit limit is, and what your payment history has been. Quickly interpreting all of this information became a challenge for financial institutions and the credit agencies boiled it down to a single number known as a credit score.
What This Means To You?
Every time you apply for credit, a record is sent to the credit agencies. If you take out a loan, or obtain a credit card they are informed as well. Over time, a picture of all of this information, including your payment history becomes your credit score. Your credit score is used by lenders to determine if you will be granted loans in the future. For that reason alone, it is important to maintain a good credit score. Unfortunately, credit scores are now being used for all sorts of reasons that have nothing to do with loans. Employers are increasingly using credit scores to screen applicants. Insurance companies have also been known to set rates based in part on customer’s credit scores. While I am strongly against such uses, everyone needs to be aware of this reality when making decisions that can affect your credit score.
How Your Credit Score Is Determined
The credit agencies actually have a policy of specifically not telling the public the exact formula they use to generate credit scores. Nevertheless, observers have deduced an approximation of how the score is computed. As one might expect, payment history is the most important factor making up 35% of the credit score. 30% is determined by debt ratio. Debt ratio is the amount of debt you have relative to the amount of credit your currently have. It might not be intuitive, but having more available credit actually increases your credit score as it lowers your debt ratio. 15% of your score is determined by the length of your credit history. Therefore, it is best to keep credit cards open for a long time, rather than cancel unused cards, especially if there is no annual fee. Of the rest, 10% is composed of the types of credit you have been extended, and 10% from the number of recent credit inquiries you have.
How To Increase Your Credit Score
Obviously, paying your bills on time is by far the most fundamental thing that you need to master to improve your credit score. Less obvious is the strategy of hanging on to your accounts for a long time. This will improve your credit history and debt ratio. Also, do not apply for credit too frequently. Many shoppers cannot resist the lure of the 10% discount frequently offered when opening up a store charge card a many chains. As a rule of thumb, I limit my credit card applications to situations where I am offered a sign up bonus worth at least $200. Anything less simply isn’t worth the hit on my credit. Finally, double check your credit reports regularly. Errors in credit reports are extremely common, and credit bureaus have little incentive to correct them. When requesting a copy of your credit report, go directly to the three major credit bureaus or through www.annualcreditreport.com, the only site that will actually offer you a free report (though the credit bureaus will always be trying to sell you their “credit monitoring services”). Many other similarly sounding sites exist to sell you some product or service in addition to supplying you your credit report. By law, you are required to be given a copy of the report every year, and you do not have to purchase anything to get it.
Having a Good Credit Score Saves You Money
With the huge impact that the three main credit bureaus have on society, it is worth noting that having a good credit score can save literally thousands of dollars in your mortgage interest for example. Even if you are not a credit addict, it always pays to maintain a good credit score as soon as you can.
The easiest way to build a credit profile is simply to use a credit card. But there is a big caveat here. You have to use it responsibly. That means paying your bills in full and using it for expenses you would have to make anyway (and not on impulse purchases). A college student (if responsible) can start building their credit with a student credit card. If you have no credit, you can start of with a secured credit card.
Your credit report is an important part of your reputation, and a good credit score is an extremely valuable asset. Learning how to maintain a good credit score is a key skill for financial survival in today’s economy.