Credit Score 101

Credit Scoring Due to the recent subprime mortgage crisis, it becomes harder and harder to apply for credit or borrow money, whether for a car loan, home-equity loan, mortgage, or any other reason. To decide whether or not to grant a loan, lenders base their decisions largely on the borrow’s credit history and one very important number - credit score.

Why is a credit score important?

It’s important because it mainly helps us save money. With a good credit score, we can potentially obtain or pay less bills on:

Unless you never need to get a job, rent an apartment, borrow money, or shop for insurance in your lifetime, otherwise, a good credit score is essential to your road to financial freedom. In contrast, a bad credit score can indicate that one is irresponsible and carries a higher risk: employers may think twice before offering a job, landlords may hesitate to hand over the key, lenders may charge a higher interest rate or deny credit, and insurers may charge a higher insurance premium or deny insurance.

Think about the money we can save on loans, mortgages, debts, and insurance policies overtime, we are talking about thousands to hundreds of thousands!

What is a credit score?

A credit score is calculated based on:

35% - punctuality of payment in the past (past due payments)
30% - the amount of debt, expressed as the ratio of current revolving debt (credit card balances, etc.) to total available revolving credit (credit limits)
15% - length of credit history (age of the oldest credit card and average age of all credit cards)
10% - types of credit used (installment, revolving, consumer finance)
10% - recent search for credit and/or amount of credit obtained recently (recent credit applications)

A FICO score is between 300 and 850, the median score is approximately 723.

Where to find the credit score?

In the US, each individual can obtain a credit history report from three major credit bureaus at no cost every year. A credit history report shows one’s ongoing/closed credit accounts: credit cards, mortgages, loans, and installments. A credit score is calculated based on the data provided on a credit history report. These renowned providers offer credit scores and credit monitoring services:

How to establish a better credit score?

Most people own at least a credit card or two (I currently have 9!). According to the formula of a credit score, you can possibly get a better credit score by:

Paying at least the minimum due amount on time every month
- Of course, if possible, the best habit is to pay the balance in full each month unless the interest rate is low or it is a 0% APR offer.
Minimizing the balance
- If the balance of a credit card is usually close to the credit limit, it’s time to request a credit limit increase or spread the balance among different cards. It can also help you avoid paying the unnecessary over-the-limit fee.
Keeping the oldest credit cards and avoiding new credit cards
- If an old card no longer suits your needs, for example, it does not offer good rebates or benefits, you can call the number on the back of the card and request a card conversion/change (banks’ best kept secret). By doing that, you can get a better card while keeping the credit history (remember, length is 15% of the credit score) of the account. On the other hand, you can easily eliminate/close newer cards by merging a new card with an old one, a credit card consolidation, if both cards happen to be issued by the same bank.
Minimizing credit applications
- If you need to open new credit cards or shop for loans, it’s best to do everything at once, like within a month. In that way, the damage made to your credit score will be limited.