September 2006
How to keep on top of your credit score
Knowing what will raise or sink it can lower the cost of loans
In fact, you're much more likely to be pushed around by another number, namely, your credit score. Lenders, insurers, landlords, prospective employers, and utility companies frequently use it to decide whether they want to do business with you and to determine what interest rates, prices, and security deposits they will charge.
Your credit score, as you may already know, is derived from data gathered by the three major credit bureaus--Equifax, Experian, and TransUnion--which track your lenders, the amounts you owe, your balances, your credit limits, your payment history, and your applications for new credit. Fair Isaac, a Minneapolis company, created the FICO score, and several other companies developed similar formulas or models that distill credit information into a score that supposedly sums up your creditworthiness or, for insurance, the likelihood that you will file claims.
Fair Isaac's FICO scores, ranging from 300 to 850 (the higher the better), are commonly used in lending. Credit-based insurance scores come from Fair Isaac; ChoicePoint, an Alpharetta, Ga., company; and a hodgepodge of insurers that developed their own models. The scoring systems vary from one company to another. At Progressive Insurance, for example, scores run from 1 to 156-plus, with lower being better; at State Farm, they range from 1,000 to 1,999, with higher being better. Fair Isaac's insurance scores run from the 100s to the 900s, the higher, the better.
It's easy to become preoccupied with the score, but that's a big mistake. The score is driven by details in your credit reports. Consequently, if you know how the two relate to each other, you can manage your report to raise your score or at least not inadvertently send it crashing.
Until recently, consumers had no idea how their credit history translated into a credit score because the companies that create scores kept the information closely guarded. But a recent Consumer Reports investigation provided one of the first in-depth looks for consumers into how these formulas work and what items of credit behavior they weigh.
Here's what you need to know about how lenders and credit bureaus handle--and manhandle--your credit information so you can properly manage your report.
1. Some positive credit information disappears
As you may already know, negative credit information must, by law, be removed from a credit report after 7 years, or 10 years after a bankruptcy. There's no such rule for positive information. Experian and TransUnion remove it 10 years after an installment loan is satisfied or a revolving account has been closed. Equifax did not respond to our requests for information.
How this affects your score: Information about old accounts is important, because scoring formulas typically give you more positive points the longer your experience borrowing money. Ideally, credit reports should specify exactly when you lost your debt-free virginity. But they may not if, say, you're 55 and that first tumble was an installment loan. So credit-scoring models use the date that your oldest reported account was opened.
How to protect yourself: Credit cards have much greater longevity on your credit report than an installment loan. So avoid closing your oldest credit-card account, even if you never use it.
2. Reporting lag times can thwart last-minute plans to improve your score
Paying down balances is one of the most effective ways to improve your credit score, according to Fair Isaac. But don't tarry, because there can be a lag between the time lenders cash your check and when they actually get around to reporting your payment to the credit bureaus.
Sometimes creditors don't even report or update payment information on consumers who consistently make their required payments as scheduled, according to a study cited in a 2004 bulletin from the Federal Reserve. About 29 percent of some 300,000 credit reports studied by the Fed contained accounts with balances three or more months out of date.
How this affects your score: The higher your balances are as a percentage of credit limits, the more your score suffers.
How to protect yourself: Pay off your account balances three to four months before you need to pretty up your credit report. "We actually recommend that consumers make the payments several months ahead of time to allow their history to stabilize before it is reviewed," says Donald Girard, a spokesman for Experian. "Unusual activity, such as large out-of-cycle payments, are a change in behavior that can be an indicator of risk, even though it is basically a positive action." Try to keep balances low all the time.
3. All of your credit limits may not be reported
The Federal Reserve study found that about 14 percent of revolving credit accounts don't specify credit limits, a lapse that affected 46 percent of credit reports in the sample.
How this affects your score: Having credit limits reported to the bureaus is crucial because they are used in credit-scoring formulas to figure out just how much of your credit you're using. If the credit limit wasn't reported, the formulas typically use a poor substitute, the highest balance you've ever run up on the card. This practice artificially deflates the limit and inflates the calculated credit-use level, depressing your score.
How to protect yourself: Information not reported by a creditor is not an error under the Fair Credit Reporting Act, so you can't dispute it. Nor can you force the creditor to cough it up to the credit bureau. If an account on your report lists the high credit but not the actual limit, you can play nice and ask the merchant to report the true limit.
4. Some creditors don't report at all, or report only negative information
If you have taken out loans with so-called subprime lenders, who offer everything from auto loans to credit cards to mortgages, you may get a rude surprise: Some may report your late payments but not your on-time record. Financing from a small automobile dealership may also lower your credit score, but for a different reason. The major bureaus now require a minimum number of loan accounts (typically 500) before they'll let a creditor report credit, and many dealers don't meet that threshold, according to the National Independent Automobile Dealers Association, which estimates that 10 million such loans are made each year. So even if you are religiously making on-time payments, that fact may not show up in your credit report.
How this affects your score: Scoring models can only give you points for positive information that appears on your report. Omissions can artificially reduce your score.
How to protect yourself: "If the lender doesn't provide us the information, we cannot put it on the file, as we have no way to go back and reconfirm the data if someone questions the data," says Steven Katz, a spokesman for TransUnion. But if a good account is missing from your traditional-lender credit score, ask the old nonreporting lender to submit the information, which will give the prospective
5. Some types of credit are looked upon with more favor than others.
Credit-scoring models often give more points for responsible handling of national bank credit cards, like Visa, MasterCard, Discover, and American Express, than, say, department-store cards. In theory at least, the big-bank cards signal the first warning of trouble. "If borrowers are going to miss a payment, they are more likely to skip this account vs. a car loan or mortgage payment," says Girard. "As a result, a credit-card history is more predictive of how they will manage additional debt." The formulas also are less likely to ding your credit if you have car or other installment loans from national banks. On the negative side, finance-company accounts will probably cause your FICO score to suffer, says Fair Isaac.
How this affects your score: A mix of installment loans and one or two national bank credit cards will improve your score. Too many of the disapproved types of credit may hurt your score.
How to protect yourself: Use the types of credit that scoring models favor and avoid the rest.
6. Loan applications generate inquiries that can count against you
Every time you apply for a loan, the lender will pull your credit report, which generates what credit bureaus call a "hard inquiry." Those are the ones that affect your score. Other inquiries, such as those initiated by lenders looking for direct-marketing prospects, insurers toting up your insurance score, and copies you request on your own, are not counted. Hard inquiries are removed from your report 24 months after they are generated.
Multiple inquiries can be generated if you solicit an interest-rate quote from an online loan broker, because that can prompt many lenders to check your report to peg their interest rate to your FICO score. You can also generate a string of inquiries if you responsibly shop around for a mortgage or car loan.
How this affects your score: Most credit-scoring models generally group together--and count as one--multiple inquiries related to car loans or mortgages that take place within 14 to 90 days of each other, depending on the formula. But if you apply for such loans more casually, outside those time frames, or if you shop around for other types of credit, you'll rack up lots of inquiries and probably hurt your score.
How to protect yourself: If you're loan shopping, do so within a 14- to 30-day period. Don't regularly apply for loans online out of curiosity about what rate you might qualify for this month. Instead, go to the loan-center area of Fair Isaac's Web site, www.myfico.com, where you can get rate estimates pegged to your stated FICO score from lenders in your area. Apply for credit only when you need it and intend to open an account.
7. New past-due items are worse than old ones
The sooner you can put a credit problem behind you, the better.
How this affects your score: Scoring penalties are larger the more recently negative items appear on your report. As those negatives recede into the past, penalties decline. The sooner you get your finances back on track, the faster your penalty points start dropping.
How to protect yourself: If you need to open new accounts to re-establish your credit rating, make sure you borrow from a lender that reports thoroughly and fully to credit bureaus.
Finally, you won't be able to improve your credit score if you don't even know what's on your credit reports. All three credit bureaus are required to provide each consumer with a free credit report annually. To get your free reports, go to www.annualcreditreport.com or call 877-322-8228. You can monitor your credit standing during the year by staggering requests from each of the three bureaus every few months.
