Your credit score is a rating that helps lenders decide whether to give you loans such as a mortgage, car loan or credit card. Your credit score also helps determine the interest rate you'll pay.
The higher your credit score, the better the credit terms you will receive. Scores range from about 300 to 850. A score above 720 can give you some of the best credit terms.
Credit Scoring and Tips
Credit bureaus use formulas to determine your credit score. Scores are based on five key factors, each with its own weighting:
1. Payment history (35%): Your track record of paying back your debts on time. A history of prompt payments of at least the minimum amount due helps your score. Late or missed payments hurt your score.
2. How much you owe (30%): How deeply in debt you are, which contributes to determining if you can handle what you owe. A good rule of thumb is not to exceed 30 percent of the credit limit on a credit card. This shows responsible debt management, which favorably affects your credit score.
3. Length of credit history (15%): How long you have had and used credit. The longer your history of responsible credit management, the better your score will be. If you have paid on time, every time, then you will look particularly good in this area.
4. Type of credit (10%): The "mix" of credit you access, including credit cards, retail accounts, installment loans, finance company accounts and mortgage loans. You do not have to have each type of account. Instead, this factor considers the various types of credit you have and whether you use that credit appropriately. For example, using a credit card to purchase a boat could hurt your score.
5. New credit inquiries (10%): Indications that you have or are about to take on more debt—such as an application for a new credit card. Applying for numerous credit cards in a short period of time will count as multiple inquiries or “hard hits” and potentially lower your score. "Soft" hits—including your personal request for your credit report, requests from lenders to make you "pre-approved" credit offers and those coming from employers—will not affect your score.
How Your Credit Score Affects You
A good credit score can save you money with lower interest rates on a mortgage or other loan. Suppose you want to borrow $200,000 to buy a house with a 30-year, fixed-rate mortgage. Based on scores and rates as of October 23, 2013, if your credit score is in the highest category, 760-850:
• Your interest rate could be as low as 3.798 percent.
• Your monthly payment would be $932.
But if your credit score is in a lower range, 620-639:
• Your interest rate could be as high as 5.387 percent.
• Your monthly payment would be $1,121.
The lower credit score could cost you $189 a month more for your mortgage. Over the 30-year life of the loan, you would pay $68,311 more than if you had the best credit score. It pays to keep your credit score in good shape.
Each individual has his or her own credit score. If you're married, and you and your spouse apply jointly for a loan, lenders will review both your scores.
What's My Score?
You might have heard of AnnualCreditReport.com, a resource authorized by federal law that provides free credit reports from each of the three major credit bureaus—Equifax, TransUnion and Experian. That same site also offers credit scores for a modest fee. While other sites advertise free credit scores, some of these sites involve costly subscriptions that you’ll have to remember to cancel.
The credit bureaus each use a slightly different statistical model for credit scores. As a result, your score from each of the three will not be exactly the same.
The key is that good credit management leads to higher credit scores, which lowers your cost to borrow. Living within your means, using debt wisely and paying all bills on time, every time, will reduce the amount you pay for the money you borrow and put more money in your pocket to save and invest.
For more information, visit SaveAndInvest.org.
Gerri Walsh is Senior Vice President of Investor Education at the Financial Industry Regulatory Authority (FINRA).
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