You might not realize it but you are part of the Wall Street financial system. Even if you carry a wad of bills to pay for everything with cash, you are on the banking system’s radar. Just about everyone has a credit score, and that determines whether you can borrow money and at what rate of interest. Nowadays, a satisfactory credit score might even be relied upon by an employer to be certain that you have no severe financial problems when being considered for a security-sensitive job.
Even though you might not intend to do so, once you enter the financial world you will begin the process of establishing a credit score. There are three major competing companies that produce FICO scores: Equifax, Experian and TransUnion. Strangely enough, you might have a different score with each credit bureau. One reason is that they could all have different information reported to them or they could receive the information at different times. Calculations would then produce different results.
Fortunately, everyone is entitled by law to a free annual credit report. Just telephone 877-322-8228 or visit www.annualcreditreport.com. If you are about to make a substantial purchase on credit, it is advisable to obtain a current report to determine that there are no errors adversely affecting your score. Creditkarma.com will provide a TransUnion and Equifax score free of charge.
When negotiating an auto lease or another purchase with a variable rate, have some idea of what the interest rate range should be for someone with your FICO score. The top credit rating is 720-850. That should provide the best interest rate available. You might be able to get the lease even with the lowest score from 300 to 640 because the car provides collateral that secures the loan, but the interest rate would be in the highest range. From 640 to 720, the score is in the negotiable range of fair to good.
As expected, if you want to buy a house there might be a reluctance to sell to you if your credit score is not at an acceptable level. If you are determined to go forward, because of the credit risk the interest rate will usually be set a bit higher to compensate for the expense of anticipated financial difficulties. That would add a monthly increase in the debt service. Even more troublesome, realtors are reluctant to rent an apartment to someone with a bad credit rating because it is possible that the financially strapped tenant might have to be evicted.
A good credit rating is especially important for a small business proprietor. Companies selling on credit to small businesses usually require the owner’s guarantee. Even though the purchase is for the business, the proprietor’s credit rating may determine whether the sale goes through. But that is not the only factor. Lenders will also consider whether or not the business owner has the capacity for more debt even if current bills are paid punctually. So small business proprietors will need more than good credit ratings. They have to manage their financial affairs skillfully.
A normal reaction to the FICO rating system is to try to influence the process. The most effective practice is to pay all debts on time. Sometimes canceling credit cards or opening credit accounts might not be helpful. It might create the impression of financial difficulty rather than credit organization. Also, paying up after a period of delinquency will not instantly improve your credit rating, but it eventually will have an effect.
As expected, the most significant element in calculating your credit score is your payment history. Do you pay on time? That has a 35 percent impact on the score. Next in importance is the amount you owe. That accounts for 30 percent of the score. Next in importance at 15 percent is the amount of credit history. Someone who has been paying on time for decades would score higher on this factor than someone who is a relative newcomer.
The above factors account for 80 percent of your credit score. There are other factors that influence the final result. They suggest that you:
- Refrain from opening new credit accounts;
- Keep the balance due on credit cards below 30 percent of the limit;
- Have creditors increase the amount of the credit limit;
- Get a better interest rate from creditors; and
- Pay off the debt with highest interest rate first.
Be sure to monitor your financials. There might be inaccurate information on your credit report from time to time. Be aggressive in disputing errors. You will not lose credit rating points by standing up for yourself.
Your money is a personal finance column written by Banner Biz staff.
