Question of the week:I've heard that it's important to check your credit score, but I've no idea of how to go about this, or if it's even worth it. What are your thoughts? --Marti O.
Dear Marti,
Ah, the elusive credit score. This seems to be one of the most mysterious--and misunderstood--issues in personal finance. But it's certainly an important part of your overall financial picture, and one that it really pays to understand.
When we asked members of the Armchair Millionaire community about whether they make it a habit to check their credit scores, we found that many do. Here are two of the comments we heard:
Prevent surprises. "I regularly (once per year) check my credit score, along with my credit report. I don't want any surprises when I need to get a loan." --Bryan J.
Make a resolution. "I check mine once a year when I check my credit reports for identity theft problems. I made it a New Year's resolution to improve my credit score last year, and it worked. I was able to raise it a bit." --Andy
In a nutshell, a credit score is simply a number that helps lenders know your credit risk. In other words, it tells them how likely you are to pay back your loan in time. While lenders may make their decisions to extend you credit based on many different factors and credit scoring models, the one credit score used by most lenders by far is the FICO score (so named because it is developed by Fair, Isaac and Company). This score is based on information on your credit report and is provided to lenders by the three big credit bureaus: TransUnion, Experian and Equifax.
While that's simple enough, it's made more confusing by the fact that you don't have a single credit score. Because each credit bureau may have slightly different information about you, and may treat that information slightly differently, your score will likely be a little different at each bureau. And because your financial situation changes all the time, so do your credit scores.
The Armchair Millionaire Guide to Credit Scoring
- Why they matter. The better your credit scores, the lower the interest rates you'll be offered. For example, according to FICO, a high credit score could mean that you're offered a 30-year mortgage at 6.3 percent. With a low score, you'd be offered a much higher rate--9.4 percent. On a $150,000 mortgage, this translates into big bucks. With the higher credit score, you would save more than $300 on your monthly payments.
- How they're formulated. FICO evaluates five primary issues in creating your credit score. Your payment history carries the most weight (35 percent), followed by the amount you owe (30 percent), the length of your credit history (15 percent) and the type of credit you're using and how much new credit you've opened recently (10 percent each).
- How to get them. Your credit scores are generally not given out as part of a regular credit report. However, you can obtain it from www.myfico.com along with your credit report, as well as online from each of the three credit bureaus. You may have to pay a few dollars extra to have your score included along with your credit report.
- How to improve them. The better you manage your debt, the better your credit score will be. Pay your bills on time, keep your credit card balances low and don't open unneeded credit accounts. If you've had problems in the past, it's especially important to get current and keep current with your loan payments.
THE BOTTOM LINE: While keeping tabs on your credit scores may seem an afterthought, remember that people with a better credit score are offered lower rates when borrowing. That could make a big difference in your monthly spending. When it comes to financial planning, little things can add up to a lot.
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