- What’s the difference between a credit report and a credit score?
A credit score is the numerical value calculated from information in your credit file that is used by lenders and landlords to assess your “credit risk” at that time. A total number of points—a credit score—help to predict how creditworthy you are, that is, how likely you are to repay a loan and make the payments on time. Credit reporting companies calculate scores in different ways, but all use a complex mathematical model to take into account factors like payment history, amounts owed, length of credit history, new credit and types of credit, among others. This score changes over time to accurately reflect your current financial behavior. In order to ensure that credit reports are fair for everyone, certain factors are not included in your score. To name just a few, race, religion, national origin, sex, age, salary, and any other information not proven to be predictive of future credit performance are never included in calculating your score.
A credit report is a summary of your financial reliability—for the most part, your history of paying debts and other bills. Credit bureaus (also known as credit reporting agencies) provide information received from credit reporting companies, like credit card companies and banks, that can be made available to a third party, like lenders and employers. In addition to identifying information, credit reports include information like the number and types of accounts you have, payment history, collection actions outstanding debt, age of your accounts, and any public record or collection items among others. It also includes a list of everyone who has received a credit report for you for a specified period of time (known as “inquiries”). Whenever you apply for a credit card, loan, etc., the company you apply with requests a copy of your credit report from one of the 3 credit reporting agencies.
- How is my score determined?
A credit score is a complex mathematical model that evaluates many types of information in a credit file to determine your financial reliability or credit risk; that is, how likely you are to repay a loan and make your loan payments on time. Many factors influence your score, with the two most important being how you pay your debts and how much debt you owe. For example, late payments on loans, a past bankruptcy, debt collections or a court judgment ordering you to pay money as a result of a lawsuit will negatively affect your credit score.
According to the Fair Isaac Corporation that calculates the popular “FICO score”, the following factors (and weighting) determine your credit score.
Payment History (35%), which includes account payment information, bankruptcy or judgments, how long overdue payments are, amount past due, and the time since any adverse occurrences.
Amounts Owed (30%), which includes the amounts owed on accounts individually and totaled together as a whole, number of accounts with balances, proportion of credit line used and proportion of installment loan amounts still owed.
Length of Credit History (15%), which includes the time since you accounts have been open as well as the time since your accounts have been active.
New Credit (10%), which includes the number of and time since recently opened accounts and proportion to total accounts, number of and time since recent credit inquires, and the re-establishment of positive credit history following past payment problems.
Types of Credit Used (10%), which includes the number of various types of accounts, like credit cards, retail accounts, installment loans, mortgage, etc.
Credit scores change over time to accurately reflect your current financial behavior and length of credit history. Accurate negative information can be reported for 7 years, with the exceptions of bankruptcy (10 years), lawsuits or judgments (7 years or until the statue of limitations runs out, whichever is longer), or information based on an application for a job with a salary of more than $20,000 (no time limitation). Since your credit score is a “snapshot”, it’s unlikely that your credit score a month ago is the same as it is today.
In order to ensure that credit reports are fair for everyone, certain factors are not included in your score. To name just a few, race, religion, national origin, sex, age, salary, and any other information not proven to be predictive of future credit performance are never included in calculating your score.
- What do the score numbers mean?
The Fair Isaac Corporation has developed the FICO scoring system which is used by the 3 major credit reporting agencies. FICO scores provide a guide to future risk based solely on credit report data. The higher the score, the lower the risk for a lender, although no score is able to say whether a specific customer will be good or bad. Lenders often use additional factors to determine whether to give credit and which interest rates to offer, and each lender has its own strategy to assess risk.
Scores range from 300 to 850, and most people score in the 600s and 700s. The higher the score, the lower the risk for a lender. Because credit scores are just a guide for lenders who use them in a variety of ways and with other information, it is impossible to say what is a “good” versus what is a “bad” score. Credit scores change over time taking into account both current and past financial performance. To give you an idea of how much payments can change based on your credit score, see the chart of how interest rates and monthly payments on a $150,000 30-year, fixed-rate mortgage are affected by the FICO credit score (as of March 2007).
Your FICO Score
Your Interest Rate
Your Monthly Payment
760 – 850
700 – 759
680 – 699
660 – 679
640 – 659
620 – 639
- How can I improve my score?
Your credit score changes over time to take into account current financial behavior and past debt and payment history. While it is difficult if not impossible to change instantly, there are several things you can do to either help or hurt your score.
Factors like when you pay your bills, your debt to available credit ratio, and your history of revolving debt rather than paying it off will all affect your score. Establish a pattern of responsible credit behavior over time, as it takes time to see significant changes in your credit score. Generally speaking, making payments on time, paying off debts, and keeping your debt to available credit ratio below 50% (though 25% or below is optimal) will help to raise your score. Also, because by very nature a credit score takes into account your financial history, if you are new to credit (for example, have just opened your first credit card) it will take time to establish a positive credit history and earn a high credit score. Exercising responsible use of your credit card over time is the best way to improve your score. See sections on 6 ways to improve your credit score and 7 common mistakes that can lower your credit score for more specific examples. Accurate negative information (like late payments) can remain on your credit report for 7 to 10 years, so make sure to use your credit responsibly now.
Inaccuracies on your credit report due to mistakes or identity theft may also adversely affect your score. By federal law, you can request one free copy of your credit report (though not your score) per year from each of the 3 major credit bureaus. If you find inaccuracies on your credit report, you can lodge a dispute to have them fixed or removed from your financial records.
- Can debt ever be good?
Not all debt is bad. In fact, a certain amount of debt can actually work to your advantage. Using credit responsibly and establishing and maintaining a strong credit history demonstrates to lenders, creditors, employers, and landlords that you are financially responsible and trustworthy. Debt from certain things, like a mortgage on a house, for example, can show to creditors that you are invested in your financial future and can use even large amounts of credit responsibly.
Using the example of a mortgage on a house, your debt can say to creditors:
I am invested in my financial future.
I intend to use my credit and debt responsibly.
I intend to always have a job or source of income so I can pay my debts.
I am financially responsible and trustworthy.
You can trust me if and when I need credit for something else.
Actions speak louder than words and your credit and debt history can tell volumes to creditors about your potential credit “success” in the future. Certain kinds of debt, like a mortgage on a house, can be positive for you future.
- Do I need to worry about identity theft?
Identity theft can make a huge negative impact on your credit score. It’s a big problem too – identity theft totaled 43% of the consumer fraud complaints made to the Federal Trade Commission in 2002. A low credit score can keep you from getting credit cards, loans, an apartment, or even a job.
One of the easiest ways to guard against identity theft is by regularly checking your credit report to make sure no one has stolen you personal information and used it to get credit cards, loans, or even rent an apartment. While federal laws and industry practices can limit your liability if you become a victim of identity theft, it can take a very long time, even years, to repair the damage if you don’t catch it in time.
Identity theft is very real and it is important to check your credit report regularly to make sure you’re not a victim. You are entitled to one free credit report per year from each of the 3 major credit bureaus.
- What factors aren’t included in my score?
Certain factors are never included in your score. According to Fair Isaac, the company that calculates the popular FICO credit score, the following factors are never used when calculating your score.
Your race, color, religion, national origin, sex and marital status.
US law prohibits credit scoring from considering these facts, as well as any receipt of public assistance, or the exercise of any consumer right under the Consumer Credit Protection Act.
Other types of scores may consider your age, but FICO scores don't.
Your salary, occupation, title, employer, date employed or employment history.
Lenders may consider this information, however, as may other types of scores.
Where you live.
Any interest rate being charged on a particular credit card or other account.
Any items reported as child/family support obligations or rental agreements.
Certain types of inquiries (requests for your credit report).
The score does not count “consumer-initiated” inquiries – requests you have made for your credit report, in order to check it. It also does not count “promotional inquiries” – requests made by lenders in order to make you a “pre-approved” credit offer – or “administrative inquiries” – requests made by lenders to review your account with them. Requests that are marked as coming from employers are not counted either.
Any information not found in your credit report.
Any information that is not proven to be predictive of future credit performance.
Whether or not you are participating in a credit counseling of any kind.
- Why are credit scores used, instead of making credit decisions on a case-by-case basis?
Because credit scores don’t take into account demographic information like race or religion, they are a truly objective measurement of your credit risk. Before the use of scoring, the credit granting process could be slow, inconsistent, and unfairly biased.
Credit scores allow:
People to get loans faster. Because scores can be delivered almost instantaneously, lenders can make credit decisions in a matter of minutes.
Credit decisions to be fairer. Credit scores use only factors related to credit risk, rather than personal feelings or bias.
“Mistakes” to count for less. Poor credit performance in the past can fade with time as recent good patterns show up on your credit report and overcomes so-called “knock out rules” that may haunt consumers seeking credit.
More credit to be available. Because credit scoring gives leaders more precise information on which to base credit decisions, lenders are able to identify individuals likely to perform well in the future, even if their report shows past problems.
Credit rates to be lower overall. Because the use of the credit score is streamlined, efficient, and helps lenders control credit losses, costs decrease for the borrower.
- How do I choose a credit card?
Credit cards come with a wide variety of “terms and conditions” and wading through the options to find the best one for you can be confusing. A few characteristics of credit cards you’ll want to consider are its:
Annual Percentage Rate, or APR. The APR is a measure of the cost of credit as a yearly rate. The “periodic rate” is calculated from this and is the interest charged to your outstanding balance at the end of each month. Card issuers may charge a fixed APR, or change it as bank interest rates or other economic indicators – called indexes – change. The higher the APR, the more you’ll pay in interest charges.
Free Period. This is also known as a “grace period”, during which time you may have finance charges and interest waived. While this may be very attractive in the first few months, make sure the terms and conditions after the grace period are what you want in a card. Also, the grace period may suddenly stop if you make a payment late, go over your limit, etc.
Annual Fee. Depending on the card and the issuer, you may have an annual fee incurred for your card. Most fees range from $25 to $50 and up for “gold” or “platinum” cards. While more and more cards have no annual fee, expect any card with “rewards” (frequent flier miles, cash back, etc.) to have some sort of charge. Make sure that the rewards you’ll get are worth the yearly charge for the card.
Transaction fees and other charges. A card may include other costs for things such as cash advances, late payments, or exceeding your credit limit. Some may also charge a monthly fee regardless of whether or not you use your card. Figure out what you’ll be using your card for and factor in the appropriate fees. For instance, if you never intend to use your card for cash advances, the fee incurred for this service should be weighed less heavily than the APR when choosing a card.
Balance Computation Method for the Finance Charge. How creditors calculate your balance and subsequent finance charge varies widely. The average daily balance is the most popular method, where the issuer totals the balance on your card from each day and divides it by the number of days in the billing cycle. See the Federal Trade Commission for information on other methods of computation.
To determine which card is best for you, think about how you plan to use it. If you expect to pay your bills in full each month, the annual fee and other charges may be more important than the APR and periodic rate. It’s a good idea to make a chart that lists the credit cards you’re considering and their applicable charges.
- Does everyone have a credit score?
Most adults will have a credit score, calculated from information on their credit report, once they apply for a credit card, take out a student loan, or sometimes even open a bank account. Financial institutions, like banks and credit card companies, supply information to credit bureaus on your financial performance which is used to calculate your credit score.
However, you may not have a credit score if you’ve never:
Applied for or owned a credit card
Taken out a loan (like for school or a car)
Opened a bank account in your name (using one in your parents’ name doesn’t count)
If you don’t have a credit score, that’s okay! But, creditors, lenders, landlords, and even employers will often look at your score (or lack thereof ) to help determine your financial reliability. Now is the time to start building your credit score so you can take advantage of it : when you open your first credit card or take out your first student loan, use it responsibly to build and improve your score and see what having a great credit score can get you.