Are You Scoring Enough? Part 2
Are you scoring enough? I am not talking about sports, video games, or other activities. I am referring to your personal credit score. As we discuss in the FinancialVerse, your credit score is extremely important and a low score could restrict your ability to get credit when you need it most. Your credit score needs to be monitored throughout your life, even as you progress through the Fulfilling Stage, or the post full-time working period of your life.
What is your score? How do you rate? Here are some observations:
The U.S. average score is 701, according to Experian. But many Americans of all ages have much lower scores.
At minimum, your score should be at least in the 670 range. If your score isn't that high yet, you'll need to exercise good borrowing behavior, take some strategic steps, and have patience. If this is your situation, you may also want to take advantage of two new programs offered by credit industry companies that are designed to improve those numbers as described below.
FICO calculates credit scores by assessing data from five categories. It closely guards the specific formula, but we know the categories and their relative importance.
Payment history contributes 35% to your score. The biggest chunk of your score is based on data about whether you pay your bills on time. Paying bills late, having delinquent debt or derogatory marks will hurt your score.
The second-largest category is amount owed, which makes up 30%. Amount owed includes (1) how much debt you are carrying, by dollar amount, (2) weight vis-a-vis your available credit, and (3) your current balances versus what you owed initially. In other words, let's say you currently owe $5,000 on a credit card with a $10,000 limit, and you originally owed $8,000. Amount owed accounts for all of that, looking at this by account and by the aggregate of debt you owe. In general, lenders don't like to see maxed-out cards or high aggregates, because people who max out cards can struggle to pay their debt service.
The third-largest category is length of credit history, at 15%. The longer you've proved you can responsibly handle credit, the higher the score in this section will be. FICO looks at the age of the credit card you've held the longest, plus the average of all cards, as well as at the individual accounts.
New credit is worth 10% of your score. The number of credit inquiries on your record counts in this category. The more hard inquiries (which imply attempts to open new credit or get a loan) over the past year the lower your score in this area may be. The number of new accounts opened also counts. Generally speaking, lenders view many credit inquiries and new accounts as a sign that you need money, which could make them nervous you won't be able to pay the bills.
Your mix of credit also is 10% of the score. FICO looks at how many different types of accounts you have such as mortgage, credit card, car loan, and student loans. They believe that the more types of accounts you've shown yourself responsible with, the better a credit risk you are.
Dealing with Low Scores
Scores below 670 are often referred to as subprime or at a level where a borrower is offered no credit or very expensive credit—this is similar to Experian's range, with "good" starting at 660 or 670. At scores below this level, many lenders won’t lend to you, and those who will are going to offer you credit at the highest possible cost or interest rate.
With a FICO score of under 600, you might be able to get a credit card or subprime bank loan, called a signature loan, but it could charge up to 36% interest, the highest allowable by law. What is most important is that you manage your credit so that it's above the 670 level.
Stay tuned to part 3 of the series when we discuss what you can do to improve your scores.