By Dr. Jennifer Hunter
Welcome back to episode 19 of the Money Moment with Dr. Jennifer Hunter.
Many people are aware that their credit score is important, but they really do not understand how it is calculated or how to build a strong credit score. There are several different types of credit scores. One of the most commonly used type of credit score by financial lenders is the FICO score. In this episode, I am primarily referring to the FICO score during the credit score discussion.
Understanding credit scores
Your credit score is an indicator of the likelihood that you will be able to repay a loan according to the original loan terms. The higher your credit score, the more likely you are to qualify for the most desirable loan rates.
Credit scores are often used to determine credit worthiness for home mortgages, vehicle loans and credit card applications. Your credit score is based on your credit history and can range from 300 to 850. Credit scores can be a deciding factor for whether a lender qualifies you for a loan. Furthermore, it can directly impact the price you pay for the loan, which can include higher interest rates, larger down payment, mortgage insurance and additional fees.
A formula is used to calculate your credit score, which includes your payment history, your current amount of outstanding debt, the length of your credit history, the number of recent inquiries to your credit report and the types of outstanding debt such as credit cards, home mortgages, or student loans.
The difference your credit score makes
A good credit score can make a big difference in the amount you pay over the life of the loan. Consider the following scenario for a 30 year, fixed rate, $200,000 home mortgage. Look at the following table to help you understand the difference in interest rates and monthly payment based on your FICO score. Please note this is a hypothetical table only being used for example purposes.
Let’s say you have a good FICO score of 760, and the interest rate offered to you would be 5.9%. Your monthly payment on a 30-year, fixed rate, $200,000 mortgage would be $1,187. Over the course of 30 years you would pay $427,320.
However, if you have a less desirable credit score of 590. Your interest rate may be significantly higher. In this example, assume a 9.3% interest rate. Your monthly payment would be $1,653 and the 30-year amount you would pay for the $200,000 loan would be $595, 080.
Over the lifetime of this loan, a borrower with a 590-credit score would pay $167,760 more than a borrower with a 760-credit score.
Understanding credit reports
If you are spending on credit, you need to make maintaining a good credit score a priority. Your credit score is directly linked to the items that appear on your credit report. It is possible for inaccurate information to appear on your credit report, which can hurt your credit score. Your credit history or credit report is compiled by a credit reporting agency (CRA). Experian, TransUnion and Equifax are the three major credit reporting agencies. Your credit report contains information about your payment history to creditors and the amount of credit you currently have available. Furthermore, public record information such as bankruptcies, foreclosures, tax liens and court-ordered child support may also appear on your credit report.
Credit reporting agencies collect information for your credit report from retail store credit accounts, credit card companies, mortgage and finance companies, utility accounts, landlords, cellphone companies, and collections agencies. Lenders review this information to determine if and how you repaid other loans in the past.
Check your credit report
Most information will remain on your credit report for several years. Therefore, it is very important that you check your credit report regularly to be certain there are not any errors. You are entitled to one free credit report per year from each of the three main credit reporting agencies.
Instead of requesting a report from each agency at the same time, order one at a time, spread out over the course of 12 months. If you time it right, you could request a free credit report every four months.
There are several ways to obtain a free credit report. Be careful about responding to ads on television and on the internet. You can receive a free credit report online at www.annualcreditreport.com or request a copy of your credit report by mail or phone. You do not need to request your credit score to ensure the accuracy of your credit report.
Build a good credit history
If you are denied credit due to a poor credit history or a low credit score, there are things you can do to rebuild your worthiness, including paying your bills on time and reducing your debt load.
To build a good credit history, be certain that you make at least the minimum payments on all your debts. You will want to pay all your bills on time every month, including credit cards, utilities, car payments and rent payments. Double check your credit report to ensure that these payments are being reported accurately.
Finally, it is important to realize that there are other reasons for being denied a loan. It is always a good idea to schedule a meeting with your lender to identify the specific reason. Once you identify the rationale behind being denied, you may be able to pursue different financing options available from other financial institutions, or government lenders.
Please tune in for the next episode, which focuses on stretching your grocery dollar.