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Your FICO Score
Named for the San Rafael-based Fair, Isaac and Co., a FICO is a numerical score of credit-worthiness assigned to anyone who has applied for consumer credit.
Until a few years ago, FICO scores had little to do with mortgage lending. Underwriters made decisions based on payment history and income-to-debt ratios. But they began to look at the relationship between credit scores and mortgage delinquencies. People with low FICO scores defaulted on loans with far greater frequency than did their higher scoring peers.
Your FICO scores may differ slightly between the three national credit bureaus, Equifax, Experian, and Trans Union. In general, however, each agency uses the following issues to determine your score.
1. Delinquencies. A 30-day late payment is not as risky as a 90-day late payment. Still, it’s best to avoid either. A single late payment can drop your score 50-100 points and take months or even years to recover.
2. New credit. Creditors expect you to open accounts in order to establish credit, but you run the risk of reducing your score by opening several credit accounts in a short period of time. It suggests you are overextended and may not be able to meet new credit obligations.
3. Short credit history. A longer credit history is more impressive than a newly established one. If possible, avoid closing old credit cards, even if you have them paid off and aren't using them regularly unless they are charging an expensive annual fee to keep them open.
4. Balances on revolving accounts near maximum limits. A consumer close to “maxing out” cards may have trouble making payments in the future. In general, you should have unsecured credit limits equal to 3-4 months pre-tax salary so that you if you choose to use credit cards for all of your purchases and pay them off in full each month you will still stay below the 25% credit utilization standard that really starts to hurt your credit score.
5. Public records (tax liens, judgments, bankruptcies). These all jeopardize a healthy FICO score.
6. Consumer credit agencies. Although they offer consumers lower interest rates and credit counseling, the use of credit counseling services negatively affects FICO scores. Exceptions include non-profit organizations like www.Greenpath.com, which negotiate directly with creditors on your behalf and are not visible to the credit bureaus.
7. No recent credit card balances. Having a very small balance without late payments can improve your FICO, showing that you manage credit responsibly. If you are afraid to use credit cards for the majority of your purchases, try using them for things you buy in similar amounts every month. Use one for gas or to pay your cell phone bill, and then pay it off right away when the bill comes.
8. Too few revolving accounts. If you fail to use credit, there is no way to evaluate your ability to manage it.
9. Too many revolving accounts. Multiple revolving accounts suggest a high risk of over-extension.
Credit scores can affect your interest rate. Some lenders establish lower interest for high FICO scores and higher interest for low scores. Some will not loan at all to people with low FICOs. And other lenders specialize in finding loans for the FICO-score challenged. If you have less than perfect credit, keep looking until you find a lender who will work with you.
Besides borrowing, credit scores and credit history play a role in everything from the job application process to the purchasing of insurance. Poor credit could raise your auto insurance rates by as much as $100/month in some markets. Collection items or poorly paid loans can lead a potential employer to view you as untrustworthy and offer the job to someone else. Credit is a valuable asset that should be managed and cultivated as much as any investment product. Properly managed, credit opens doors and greases the wheels of many major life decisions, including the purchase of a home.