Understanding your credit score

It’s inevitable: sooner or later, you are going to borrow money. Whether it’s a loan for a car, a house, or the simple convenience of a credit card, you are going to send in an application.

This will prompt a second inevitability: a lender will pull up a copy of your credit report and credit score.

If you have stellar credit, this is a very good thing. A lender will see that you’ve always paid your bills on time, that your existing credit balances are low, and that you have no negative marks on the accounts you’ve held for years. You’ll be noted as having prime credit, and if the other information you’ve submitted on your application is favorable, you will likely be approved for your loan at a low interest rate.

But if your credit has a number of scratches and dents, it could be a different story. With substandard credit, you could end up paying your loan back at a higher interest rate, or worse, you could be denied — which may not suit your life plans.

Here’s the thing to remember: if your credit is bad, it doesn’t have to stay bad. Your credit score and your credit report are always changing. With every new month, creditors report new information, and the oldest marks drop off of your report. Given enough time, you’ll have the chance to influence your score in the direction that suits you best: up.

Let’s start with some fundamentals, as we set out to improve your score. For instance, why do lenders look at your credit report and credit score?

Lenders take on some risk when they extend credit, and they’re more willing to lend if they know the risk is low. If you’ve paid all your bills on time in the past, you’ll probably do so in the future. So lenders check on your history by ordering your credit report, which lists all of the loans and lines of credit that you’ve opened or maintained in the past seven years. The report also lists your payment activity, balances, limits, collection items, public records, and other information that gives the lender a clear picture of your credit behavior.

For a quick snapshot of your creditworthiness, lenders look at your credit score. Your credit score is calculated from a mix of information in your credit report, with certain factors weighted more heavily than others.

In your FICO score (the most common credit score), your history of payments counts for 35 percent of your score. Another 30 percent of your score is based on your credit use, i.e. the amounts and proportions of credit you’ve used. The length of time your accounts have been open determines 15 percent of your score, while another 10 percent depends on your mix of different kinds of credit accounts. The last 10 percent depends on the number of new account openings and inquiries you have on file. Timing is also important: recent behavior has more significance than activity that occurred several years ago.

Your FICO score will fall somewhere in the range between 300 and 850, with 850 as the highest score. The higher your score, the more access you’ll have to credit from lenders.

Next week, we’ll make sure you’re getting all of your credit score points with a close look at your credit report.

Michael Camacho is the president and chief executive officer of Personal Finance Center. He has more than 18 years experience in retail banking and with financial institutions in Guam and Hawaii.

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