Knowing the Score
By Don Kuehn
I have written in the past about the value of regularly checking your credit report by going to www.annualcreditreport.com. By checking one of the major credit bureaus (Experian, TransUnion or Equifax) every four months, you can keep track of any changes to your financial status for free and make corrections before any reporting errors sabotage your creditworthiness.
If you’re planning a major purchase or need to borrow money, I'd also suggest going to www.creditkarma.com. It's a free source to get your credit score—the major factor in determining whether you are creditworthy in the eyes of lenders and whether you can qualify for those lowest advertised mortgage, car or credit card rates.
Credit Karma uses information on your TransUnion credit report. Credit scores generally range from 300 to 850 (the average score is 664). One of the things I learned on the site was that only about 5.7 percent of consumers have a score above 800, and 21.6 percent have scores over 750 (a grade of A). Scores over 635 would be considered a C—still creditworthy for most lenders, but only at a higher interest rate.
If a consumer has a credit score of 680, a 30-day credit card delinquency will lower it to 600 to 620 (a D); "maxing out a credit card drops the score by another 10 to 30 points; a foreclosure costs 85 to 105 points, and a bankruptcy shrinks it by 130 to 150," according to an AARP report. "If those same missteps are made by the owner of a 780 FICO score with few signs of risky credit behavior in the past, the number of points lost could be about 50 percent higher."
That's because a sudden change in your repayment habits signals to lenders that something's wrong. It might be a job loss, a medical crisis or divorce, for example. Therefore, your score will fall farther and faster than someone whose past credit record might not have been as pristine.
I like the Credit Karma site because the "Credit Report Card" feature gives you a clear explanation about each category that makes up your score and lets you compare your status with that of the general population. For example, did you know that 61.7 percent of consumers pay their credit card debt on time each month, or that three-quarters of credit lines have been open for six years or fewer?
These are the categories and descriptions Credit Karma highlights on your Report Card:
Open Credit card utilization—Credit Score Weight: High
Credit card utilization is defined as your total credit card balances divided by your total credit card limits. The utilization percentage is often correlated to your credit score.
Percent of on-time payments—Credit Score Weight: High
On-time payments are a strong indicator of your credit score. Paying bills on time is the best way to maintain a good credit score.
Average age of open credit lines—Credit Score Weight: Medium
Credit history is a significant component of your credit score. Accordingly, the average age of your credit cards can be a strong indication of your credit history. Care should be used in keeping old accounts open and in good standing.
Total accounts—Credit Score Weight: Low
Total accounts is another measure of your creditworthiness. Consumers with more credit accounts generally have better credit scores because it means more lenders are willing to grant credit. This metric represents the total number of accounts listed on your credit report. A breadth of different account types is indicative of good credit.
Total hard credit inquiries—Credit Score Weight: Low
Inquiries for credit, also known as hard inquiries, are placed on your credit report whenever you apply for credit. This metric takes into account the number of inquiries reported on your credit over the last two years. It is important to note that soft inquiries, like the kind used by Credit Karma, do not affect your credit score and are not counted.
Debt-to-income ratio—Your debt-to-income
(DTI) ratio compares the difference between your monthly income and the monthly amount you spend to maintain your debt. It is often a metric used when evaluating loan applications. Lower DTI is considered to be a better credit risk.
If you’re thinking about canceling an old credit card because you have finally paid off your balance, stop! The longer your history of credit with any lender, the better. Even if you're not using a card anymore, keep it. Canceling an old card shortens your overall credit history and lowers your score.
Potential lenders not only want to see that you can manage the credit you have, they also like to see a variety of different kinds of accounts: revolving, mortgage, installment loans, credit card, etc.
I was a little surprised to see that one-third of the population has 20 or more lines of credit open. Although this is a low weight factor in determining a credit score, managing that many loans and credit cards is way more work than I care to take on.
My measly 10 lines of credit (seven open, three closed) resulted in the only low grade I had on my score: a D for total accounts. Regular readers know that I am not a big fan of debt, so I lose points for not having a mortgage or car loans or department store revolving charges—a "penalty" I'm willing to pay.
Another factor that weighs heavily on a lender's willingness to loan money is your debt-to-income ratio. Just like it sounds, this category estimates how much of your monthly income it takes to maintain your outstanding debt. Check it on your Credit Report Card.
This site offers other cool tools as well. Thinking about adding a new credit card, transferring a balance, or taking on a home equity line of credit? The "Credit Score Simulator" will estimate how these decisions can affect your credit score.
Want to calculate payments on a loan, find out how much house you can afford or how long it will take to pay off your credit card? There are calculators on this site to help. There are also tabs for credit advice, Q&As and "credit compare" tabs for credit cards as well as local mortgage, savings and auto loan rates.
While this site is not advertising-free (what site is?), the amount of usable, valuable information available is uncommon among the places I have researched. It is well worth your time to visit. Did I mention that it's free?
Making the most of your money means using credit responsibly and anticipating how the decisions you make will influence your ability to leverage your income through prudent borrowing. Knowing your credit score and monitoring your credit reports is the place to start.
Don Kuehn is a retired AFT senior national representative. For specific advice relative to your personal situation, consult competent legal, tax or financial counsel. Comments and questions can be sent to email@example.com.