DINKs on Credit Scores

by James & Miel on September 8, 2009 · 0 comments

In my last post I talked about a friend of mine who had difficulty getting a credit card due to a high student loan balance. It has always been important to know your credit score, but it’s especially important now to be diligently tracking your credit rating since the economy is continuing to struggle.

Most people are familiar with FICO as well as the three major credit reporting agencies: Equifax, Experian and TransUnion. FICO (stands for Fair Isaac COrporation, named after its two founders, Bill Fair and Earl Isaac) is the creator of the credit scoring model, which builds a statistical model of credit worthiness, which is used by the credit reporting agencies to generate a credit score.

If you’ve recently looked at your score from each of the three agencies, you may notice that the scores are different for each agency. This is because each agency has its own methodology and data that they use with the FICO model to generate your score. Most of the time the scores are relatively similar, but there may be large variations, depending what’s in your credit history. That is why most people recommend you look at the data that all three major credit reporting agencies have, as there may be inconsistencies between them.

The actual makeup of the credit scoring formula FICO has developed is proprietary information, so we don’t know the exact makeup of the model. But they have released a general outline of the formula, which can be found here. The formula is made up of the following parts:

  • Payment History (35%)

This includes late payments, defaults and bankruptcies. Although all given percentages are approximate, this is clearly the most important factor, and the one you have the most control over. You should nail this one in order to get a good score.

  • Total Debt (30%)

This is where your credit utilization comes into play. Here they look for how much total you owe, how many accounts with outstanding balances you have, and your ratio of debt-to-credit. Opinion varies on what a good debt-to-credit ratio is, but typically you want to have a credit utilization of less than 30%, but obviously the smaller the number here, the better for your overall score.

  • Credit History Length (15%)

This is pretty self-explanatory; typically accounts in good favor and more than three years old are the key here. Unfortunately for many young people, or people who have previously relied on a cash-only system, this can end up hurting their credit score, even if their income and lifestyle wouldn’t otherwise cause them to be viewed as a credit risk.

  • New Credit (10%)

This is another controversial aspect of the credit score, because if you’re looking for a new credit card, you may apply to a couple different ones in search of the one with the best rate. When a vendor checks your credit, your score takes a little hit, regardless of whether you are extended a line of credit or not. The best way to mitigate those little credit dings is to be very focused when researching credit cards, and be careful to not open numerous lines of credit within a certain period of time, usually a month.

  • Misc (10%)

This is where everything else goes: type of credit applied for, income, and even such things as marital status and whether you’re married or single are included here. Clearly this is the least-defined aspect of your score, and can often account for the variations in scores between credit reporting agencies.

Nowadays, there’s a ton of information out there about credit scores. Watch TV past 11pm and you’ll see scores of ads devoted to “free” credit reports or credit monitoring services. My personal favorite is the guy who claims to be so confident in his credit monitoring service that he’s supposedly willing to share his Social Security number with the world. That is so incredibly stupid, but I can’t help but laugh whenever that commercial comes on. I have not checked out each of those companies, but I am typically dubious about their products. Most claim to offer a free credit report, but most also require that you sign up for their credit monitoring service in order to get it.

You are guaranteed by federal law a free copy of your credit report once per year, but only AnnualCreditReport.com is authorized by the federal government to provide that to you. Note that this does not include your credit score, just your credit report.

Obtaining your credit score is usually something you have to pay for (usually around $50).

If you are serious about working to improve your credit rating, we’ve found credit.com to offer a reliable and well priced provider of all three score monthly, as well as some other features around fraud prevention.

It’s obviously important to keep tabs on the health of your credit. Many long-term financial purchases revolved around having good credit in order to get the best rates (e.g. mortgages and auto loans). Credit reports are also often used when applying for jobs. This may be most applicable out here in Washington, D.C., but if you’re applying for a highly cleared position, you could be denied based on having too much debt (you’re considered a security risk, based on the fact that you’re heavily in debt and could be influenced by money).

So keep your credit clean, keep tabs on its health by using whatever free tools are at your disposal, and you’ll reap the benefits of getting the best rates on future purchases.

– Michael

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