It’s Called Currency

You’ve heard all about the ever-important credit score, right? You’ve got to have a good one if you’re looking to buy a house or get a car loan with a reasonable interest rate—or even get approved for the loan in the first place. A recent development is that a bad credit score can even keep you from getting good insurance rates or some jobs. But what, really, is your credit score? How do they come up with that number and what’s actually a “good” number to have?

The most widely known credit score is the FICO Score as outlined by Fair Issacs. This score looks at 5 categories: payment history, amounts owed, length of credit history, types of credit in use, and new credit. Different percentages are applied to these categories, giving them different weights in your overall score, and the percentages may be assigned differently to people in specific situations. Here’s how it breaks down for the “average” person: At 65%, your payment history (35%) and current amounts owed (30%) make up the majority of your score. The length of your credit history accounts for 15% percent, while the types of credit and new credit each account for 10%.

You can see that making your payments on time is going to help you greatly in achieving a good score, as will sticking to a reasonable debt-to-income ratio (where you have more than enough money coming in to cover your debts after your monthly bills are paid). Having a long history helps, but it isn’t crucial, nor is the variety of credit types. Something that may be weighted more heavily is if you have just acquired credit somewhere else when you go looking for new credit.

Remember that this score is a system designed to assess your risk level, meaning that the bank or other lending institution is looking to find out how likely it is that you will actually pay back the money they loan you. If you feel that the number doesn’t accurately reflect your current situation, you may be able to have them look at other factors that will play in your favor, such as a successful history with your regular monthly bills. If you’ve recently been through a major life change like a divorce or the death of a partner or child, your score may say something different than what you know to be true about you. These kinds of life situations can be taken into account by a good loan officer, but they will also need to see some evidence that you’ve thought through this loan and made a plan for how it will be repaid. If you can demonstrate your ability to plan for the future and stick to your plan, you may be able to persuade them to approve the loan in spite of a low credit score. If you get turned down, try again with a different loan provider.

Some tips to help keep a good score or improve a bad one:

• Always pay your bills on time.
• Bring any past due payments up to date and keep paying them on time.
• Whenever you encounter problems in making your payments on time, contact your creditors before you get behind. Communicate with them and ask what options they may have to help keep your account from getting behind.

As you work to clean up your credit, you may be able to make arrangements for paying less than what was owed or even having a creditor write off or charge off the entire balance. If this happens, bear in mind that you may have to pay taxes on any amounts not actually paid as if they were income. This one hit me by surprise when I was trying to clean up my credit after my divorce. I found out about it when I received a 1099 just in time for filing my income tax return. Don’t let it be a surprise to you.

A good credit score is important and achieving one is actually pretty easy: keep your promises. If you keep each promise to pay, and ensure that they are paid on schedule, your score will reflect your personal integrity, and personal integrity looks like “low risk” to lenders. To you, it just looks like smooth sailing.

Check out this booklet for much more information: Understanding Your FICO Score

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