Rachel Haig: Hi, I'm Rachel Haig for Morningstar.com. Credit scores have gotten a lot of attention since the beginning of the credit crisis. So what score is good enough to be considered creditworthy?
Your credit score, also known as your FICO score, is a large determinant of what types of credit you have access to, and at what rates. According to CNNMoney, someone with a score of 580 will likely pay three more percentage points on a mortgage than someone with a score of 720. And with currently strict standards, a score in the 500s may make it difficult to qualify at all.
So how exactly is your score calculated, and what can you do to improve it? Your score can range from 300 to 850, based on five factors outlines by FICO.
First is payment history. This part of your score is the largest component and is based on the number of payments past due, how far past due they were, and how recently late payments occurred.
Second is amounts owed. This section looks at how much you owe, the number of accounts with balances, and how much of your available credit you are using. Also known as your credit utilization ratio or debt to credit ratio.
Third is the length of your credit history. As you would expect, this takes into account how long you have had credit. The time since accounts were opened and since they were last used are both factors.
Fourth is new credit. This looks at the proportion of accounts that were recently opened, and the number and recency of new credit inquiries. Inquiries occur whenever you apply for a credit card, car loan, or other line of credit, and the originator requests your credit score. Only inquiries that you initiate by applying for new credit count against your score. So checking your own score will not count against you.
Fifth is types of credit. This looks at the variety of your credit lines. Having a healthy mix of different types of credit, such as credit cards, a car loan, and a mortgage improves your score, as long as you stay current on all of your accounts.
Keep in mind your credit score does not factor in your employment status, income, age, gender, or any other non-credit-related information.
So what are some things you can do to increase your score?
First, check your credit report at least once each year. This will not only help show you where you stand but will also help you identify unauthorized accounts. Quickly dispute inaccurate information or accounts that are not yours. You're legally entitled to a free report annually from each of the three major providers, Experian, TransUnion, and Equifax.
It is normal for your score to vary slightly between the three reports. It's a good idea to space out your requests from each, so that you can see a new report every four months. Annualcreditreport.com is the official site to access your free annual report. Another useful free resource for free credit information is creditkarma.com.
Second, re-establish on-time payments. The longer your history of on-time payments, and the further you get from missed payments, the better your score will be. Opening a new account and paying it off consistently will eventually raise your score. Items such as bankruptcy affects your score for seven years, but you can start minimizing the damage in as little as two years with on-time payments.
Third, keep your credit usage low as a proportion of your total available credit. Also, don't cancel accounts you no longer use, because doing so would decrease your available credit and thus increase the amount that you're using.
If you have accounts that you are no longer using, but are still open, it's important to keep an eye on them in order to protect yourself against fraudulent use. If you have cards that you're not using that charge high annual fees, though, you should think about closing them.
Fourth, if want to close multiple accounts, space them out, rather than closing them all at once. Same goes if you're trying to open multiple new accounts.
And finally, keep your rate-shopping period for car loans and mortgages to 30 days to make sure it's all treated as one inquiry.
Knowing how your credit score is calculated and what you can do to improve it are the first steps to improve your creditworthiness. For Morningstar.com, I'm Rachel Haig.