Most People Don't Know Enough About Credit Scoring, So Here Are the Things You Need to Know
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Most People Don't Know Enough About Credit Scoring, So Here Are the Things You Need to Know

Your credit score is one of the most important numbers when it comes to how much you pay to borrow money, so you should understand how that number is made and changes

December 19, 2019

Most people are able to answer basic questions about credit scoring, but don't really know as much as they should. Most people don't know details or get things wrong. Because credit scores play such a vital role in how much you pay when borrowing money, it's important that you understand some key things about credit scoring. Knowing some of these things can save you a lot of money in the long run.

Credit reports are not the same as credit scores

While you might understand the difference between credit reports and credit scores, not everyone does. In fact, it's fairly common for people to be confused about the differences. Your credit score,which is a number, is an indication of your credit worthiness. It gives potential lenders an idea of how likely you are to repay your debts. The credit score, which varies from one credit reporting agency to another, is built from the information on your credit report.

Each credit reporting agency calculates things a little differently

There are three major credit reporting agencies or credit bureaus, as well as the newer VantageScore. They all calculate credit scores a little differently and each have different high and low ranges. And because each credit score comes from the information on each credit bureau's report, your score can vary greatly from one to the next if the information is different. That's why it's important to check your report at each of the credit bureaus.

Credit scores are determined by different factors

Your credit score is built from a detailed record of your credit history, including types of accounts, how often you apply for credit, public records, etc. There are a lot of factors that contribute to scores, but some are more important to others..

  • Payment History: When you make a late payment, it can lower your credit score. How often you make late payments factors into your overall credit score. Payment history is the biggest part of the credit score.
  • Credit Utilization: Credit utilization refers to how much of your available credit you are using. You should aim to use less than 30% of your overall available credit.
  • Age of Accounts: An old account, especially one that has been paid on time, is better than a new account. It shows that you are capable of making payments over time.
  • Types of Accounts: When you have multiple types of accounts, you show that you are capable of managing your debt. Likewise, if you have a lot of revolving accounts, such as credit cards, it might count against you.
  • Credit Inquiries: Applying for credit places an inquiry on your credit report. Lenders don't like to see a lot of inquires, which means your score goes down a small amount as the number of inquires increases. The exception is when you are applying for the same type of account within a short amount of time e.g. new mortgage.

Checking your credit doesn't hurt you

When you apply for credit, your score can fall by a small amount for a short period of time. But when you check your own credit report or credit score, your score isn't affected at all. You aren't penalized for checking your credit report or score to make sure everything looks good.

you don't have to pay for credit reports

You are legally entitled to get one free credit report each year from each of the three major credit bureaus (Equifax, Experian and TransUnion), which are available only from this website. NCCC helped pass the federal law that brought this important benefit. Be cautious of getting credit scores and credit reports from other sources, which typically try to rope you into recurring charges for credit monitoring services.

Even if you don't suspect a problem, you should be checking your credit reports to find errors and potential fraud each year. If you believe that you are a victim of fraud or identity theft, you can also request a free credit report from the three major credit bureaus if you have already received your free yearly report.

credit errors and low scores can cost you thousands

If there is an error that results in a negative item being listed on your credit report, it can lower your score a little or a lot. If you're not paying attention and an inaccuracy is lowering your score, it can cost you a lot of money in interest charges when you apply for new credit. Even a change of a few points can lower you from one credit tier into another, which can prevent you from getting the best interest rates.

Even if there aren't errors on your credit report, not taking the opportunity to improve your credit worthiness before applying for new credit can cost you a lot. To rebuild your credit when there are negative items, you should use credit sparingly, make your payments on time, and apply for credit only when you absolutely need it. It could take a while for your score to improve dramatically, so be patient. And even if your credit score doesn't improve by much, demonstrating that you are improving can mean a lot to a new lender.

joint credit scores don't exist

A credit score is unique to one person, which means that your score won't rise or fall just because your spouse's score does. The only time another person's credit worthiness can affect yours is when you share an account with the person. If that person allows the account to build up charges or fails to make payments, it will show as a negative item on your credit report and affect your score accordingly.

Everything Eventually goes away

Even if you have the worst credit report possible, those negative items will drop off with time as long as you bring the affected items into good standing and keep them that way. The amount of time varies, but even a bankruptcy can disappear from your credit reports with enough time.

not all lenders use the same score

Many lenders use a FICO score, which standardizes information from the credit reporting agencies, and some use VantageScore, which was developed by the major credit reporting agencies as an alternative to FICO. One lender might be using FICO 8 while another is using the newer FICO 9 or VantageScore 4. Each of these different models can result in a different score. So just because you see a score of 800 doesn't mean that your lender will see the same number.

one credit report may be different than another

Each credit bureau receives information from a variety of sources. But just because an item is listed on one credit report doesn't mean that it will be listed on another. When you're preparing to apply for credit, you should ensure that all of your credit reports are accurate, not just one or two.

Credit Repair companies

Legitimate credit repair companies do exist that can help you figure out how to best improve your credit. But you should be very careful if you decide to go down this road since scammers prey on people who are desperate for a quick fix. Avoid any such companies that want a payment up front or ask you to misrepresent facts.

Late payments don't always make it to your credit report

If your creditor reports late payments to the credit bureaus, they must wait until you are at least a full 30 days past your due date. This is helpful if you accidentally overlook a payment. While the item won't be reported to the credit bureaus, you might still incur late fees or additional interest.

Credit scores are part of the equation

When it comes to getting credit, your credit score isn't the only thing that matters. Sometimes if the credit score is the only issue between you and your loan and was lowered because of a single item, you can explain the situation in order to clear up a potential issue. But your ability to repay a loan matters just as much. If you aren't currently working, haven't been working long, or bounce from job to job, how can a lender be confident that you will be able to repay the loan? The credit decision is made after looking at the entire picture, not just the part of the picture that includes your credit score.

What's a good credit score?

Remember that credit score ranges vary from each credit bureau to the next. But, generally speaking, credit scores of 800 or more are considered excellent. Lenders typically start to ask more questions when your score is below 700 and typically don't like to see scores below 600.