A good credit score is vital for loan approval and can help you borrow at lower interest rates.  Depending on how much you borrow a good FICO credit score could be worth hundreds or thousands of dollars.

What is a good credit score?

A good credit score falls in a range of 675 – 850, the strength of the score depends on which credit scoring system you’re using.

Good Credit Score Range

Before you get a handle on what is a good or high credit score, you first need a basic understanding of how the scoring goes. FICO, which is the primary credit score that lenders around the country use, starts at 300 and goes up to 850. A good FICO score starts at 675 and goes to 699. A very good credit score picks up at 700 and goes to 799. An excellent credit score ranges from 800 to 850.

Prior to the downturn in the economy and stricter lending guidelines, a good credit score could get you far. A good credit score could get you an auto loan, mortgage or credit card, with favorable terms and a fair interest rate. Since the downturn in the economy and the stricter lending guidelines, your credit score has to be higher to get approval from some lenders.

Journey to a Good Credit Score

The calculation of your credit score has of five components: payment history, balances, credit history, types of credit and new credit. Each component has a higher weight than the one that follows it, so these are in order of importance. If you want to boost your credit score into the good, very good or excellent category, then these five components play a vital role.

1. Payment history (35%)

The primary way to boost your credit score is always make your payments on time.

2. Balances (30%)

The second way to boost your credit score is to maintain manageable balances on your credit accounts. If all of your credit cards are at the limit, then pay down or pay off the balances. Maintaining a manageable debt level is another boost to your score.

3. Credit history (15%)

Time is on your side when attaining a higher credit score. When you have long and positive relationships with your creditors, this boosts your credit score. Avoid opening and closing credit accounts and loans. Instead, maintain your account and credit relationships.

4. Types of credit (10%)

You should also vary the types of credit accounts you have. Having a mixture of credit cards, auto loans, student loans, mortgages and store credit accounts can help. You can attain a good credit score more easily if you have a mix of credit account types.

5. New credit (10%)

Finally, establish new credit accounts once in awhile. If you do not have a combination of different types of accounts, this is an opportunity to open a new account using a new type of credit.

What’s a Good Credit Score Worth?

Your credit score may actually be used as a criteria for more than approval for a car loan or home loan these days. In some cases employers, rental agencies, and insurance companies may check your credit score before hiring you, renting to you, or writing an insurance policy for you.

The impact of these uses are hard translate into dollars since your credit score isn’t used in all cases and we don’t know how exactly its being used.  Just be aware that the value of a good credit score goes beyond approval and interest rates on loans.

It’s not simple to say for sure how your credit score will impact your loan application since there are different credit scoring systems and lenders use other criteria in addition to your credit.  One thing’s for certain, the more money you’re borrowing, the more you’ll pay in interest. So your credit score often has the biggest bottom line impact on a home loan.

You can get an idea of how much a good credit score can save you, or a bad credit score can cost you, from the credit score calculator on the MyFICO site.  Below is a snapshot of the estimated monthly payments for each credit score range on a 30 year fixed mortage of $300K.

As you can see the savings from one credit score tier to the next is significant. If you compare the best credit score tier to the worst credit scores you’re looking at almost $300 a month difference.

Bad Credit?
If you’re in the bottom tier of the table you’ll obviously have to pay a higher interest rate, which means thousands of dollars over the life of your loan. Not only that, lending requirements have tightened enough that you may not be able to get a loan at all. So how can you build up your credit history to improve your credit score if no one will give you a loan?

One of the best ways to rebuild your credit is to use a secured loan or a secured credit card.  Since the loan is backed by an asset, the lender is willing to take the risk of loaning you the money.  If you make sure the lender reports to the credit agencies (Equifax, Experian, or TransUnion) and that you send in all your payments on time this approach should help improve your credit.

How to Check Your Credit Score
If you’re not sure where your credit score stands, there are several ways that you can check your credit score.  In fact, you can get a free credit score from multiple sources online.

The FTC established a site called Annual Credit Report where you can get a free credit report several times a year.  Unfortunately it doesn’t include your credit score but there are places you can check it without paying.  Some of the sites, like Credit Karma, are free because they use a variation of the FICO score.  It may not match your FICO score exactly but can give you a rough idea of where you fall.

Of course, we’ve seen that the difference between credit tiers can add up to hundreds of dollars a year in interest expenses.  If you want to know exactly what your FICO score is then you can sign up for a free trial of several different services.  As with all free trials, if you don’t cancel after the trial is over you’ll pay a fee.

• myFICO
• Experian
• TransUnion
• Equifax

Unfortunately, that’s just not the way the system works anymore. Your credit report is a convenient compilation of your financial habits and history, and it is easy to use the information in your credit report — or even to use your credit score — as an indication of what sort of risk you might pose in a number of financial situations.

Judging You Based On Credit History

Anymore, an increasing number of people are making judgments about you based on the information found in your credit report. You may rankle at the injustice, but it’s still there. Here are some of the ways that having a bad credit score can hurt you — even if you don’t want to borrow anything:

Opening a bank account: Believe it or not, there are actually some financial institutions that will run a credit check on you before allowing you to open a deposit account. Before you can open a savings account or a checking account, you might have to submit to a credit check.

Banks want to know, especially in the case of savings accounts, that you are likely to park a big chunk of money there — and leave it for a while. Plus, even though overdraft fees are a big moneymaker for banks, they don’t want someone who habitually goes in the red, and your credit report could provide a clue.

Insurance premiums: Many insurance companies check your credit score when deciding on your insurance premiums. My insurance company regularly sends me a letter telling me that my credit score has resulted in a discount on my car insurance premium.

Over time, a good credit score can mean hundreds of dollars saved in car insurance premiums. If you don’t pay attention to having good credit, then there is a good chance that it will cost you.

Rentals: What landlord wants to have to worry about whether or not you are going to make your monthly payments on time? As a result, some landlords will check your credit before approving your application.

In some cases, you might have to live in a less desirable rental if you don’t have good credit. (Of course, if you already have a home, this doesn’t matter as much.)

Certain jobs: My brother in law was subjected to a credit check when he applied to be a security guard. He was rejected because some companies have concerns that someone with poor credit might be vulnerable to bribes.

Certain employers might want to take a look at your credit report before hiring you. If it looks as though your habits might not have been the most responsible, you might be passed over.

Building Your Credit
It’s frustrating for people who are trying to be financially responsible and avoid debt of any kind – only to find out they don’t have a good credit score since they have no credit history.  The good news is you don’t have to go into major debt to build your credit score.

One option is to start using a credit card, and pay off your balance monthly.  If you only charge what you have money to pay for it can help you improve your credit score while at the same time keeping you debt free.

Another option is to use secured loans to build up your score.  Banks may not be willing to give you a regular loan if you don’t have a credit history. What you can do is $1000 into a 12 month CD, then use the CD as collateral for a secured loan.

1. Spending More Than You Earn
The root of most financial problems is the inability to control spending. No matter your income level, if you spend more than you earn you will be broke and in debt. Whether you have $10,000 in income or $1,000,000 in income, you must spend less than you earn.

2. Not Doing an Annual Review of Your Finances
It’s “okay” to make a money mistake for a little while if you are unaware of it. Real problems start if that mistake sustains itself for years on end. Sitting down at a specific time every year to review your finances can ward off these problems.

You might notice an extra fee on your cable bill due to a data entry error. Or you can make it a habit to comparison shop your car insurance and home internet costs in order to negotiate for the best rate. They say ignorance is bliss, but it can cost you dearly.

3. Over Paying for Convenience
It’s easy to justify spending money when it is convenient. You don’t plan out your meals and find nothing in the fridge to eat, so you go out to a restaurant and spend enough money to feed you off of groceries for a week. You need your coffee in the morning, but instead of getting up a little bit early to make it for pennies per cup you spend $5 at Starbucks. Paying for convenience is fine, but do it all the time and in excess and you will always wonder why you never got ahead financially.

4. Avoiding Tough Decisions
Sometimes life is tough. Sometimes your income goes down or disappears. Sometimes your bills go up dramatically. During those times you have a choice: you can try to finance the gap between what you make and what you spend, or you can start cutting items from the budget.

Having an argument with your spouse and whether to cut cable or not isn’t fun, so you avoid the conversation even though you could really use $100 per month to buy groceries. At the end of the day if you have the necessities of life: food, water, shelter, clothing on your back, your health, and a way to generate income to live, you’ll be okay.

5. Not Protecting Your Credit Score
A bad credit score can cost you thousands of dollars in interest. People with bad scores are seen as credit risks, there’s no doubt your credit score impacts your interest rates. It might cost you $1,000 on a car loan or $40,000 on a home mortgage to have a bad credit score. That’s a mistake when you can improve your credit score by making your payments on time and lowering your overall debt utilization.

6. Spending Impulsively
A big mistake many people make is buying impulsively. They see something they want (or think they want, thanks to clever commericals), and it is right in front of them so they buy it. A few weeks later they discover they don’t really use what they thought was so important, and have wasted money.

Before making a big purchase, sleep on it. Your emotional craving for the item should die down after a while and you may come to your senses with the realization you didn’t really need it in the first place.

7. Avoiding Preventative Maintenance
Doesn’t it make sense to spend a few dollars now in order to save hundreds of dollars later? Avoiding maintenance is one of the easiest mistakes to make because it doesn’t usually immediately impact you. You avoid some car maintenance and it saves you $300 now, but the engine blows up a year from now costing you $3,000 for it to be rebuilt.

Or maybe you live an unhealthy lifestyle and don’t exercise. It doesn’t cost you much today to sit on the couch, but when you have a heart attack or stroke earlier than you should the cost will be real. Spend the time and money necessary for preventative maintenance and avoid the major costs on the back end.

8. Thinking Everything is an Emergency
It is wise to have an emergency fund handy for when things go wrong. Having 6 to 12 months of living costs set aside really protects you from unemployment or big disasters. But even if you’ve been smart enough to build an emergency fund, you can start to think everything is an emergency. That’s a mistake that can whittle your emergency fund down below what you really need, and when the actual emergency comes along you aren’t financially prepared.

9. Letting Compound Interest Work Against You
Compound interest is a beautiful thing if you are the one with the money being lent out. If you deposit funds into a savings account, you are letting the bank borrow from you to lend to others. They pay you interest for this privilege. On the flip side if you are carrying a balance on a credit card or taking out payday loans, compound interest works against you.

10. Paying Your Bills Blind
A simple mistake to make is to simply pay your bills without looking at them in detail. Every bill you receive has a summary of the charges and then a breakdown showing what you were charged. It is easy for companies to have data entry “mistakes” that throw an extra charge in on your account. If you don’t review the bill it can easily slip past you. While setting up online billpay and automatic payments is a good thing because it helps you avoid late fees, be sure to check the actual statement to make sure you were charged the right amount.

Bankruptcies and Foreclosures

If you have a low credit score, with no bankruptcy or foreclosure, you might be able to purchase a home now. You will have to pay a higher interest rate, and you might not get the best loan terms, but you probably won’t have to wait — as long as you have a large down payment and a credit score above 500. (If you have a small down payment, you might not be able to get a bad credit mortgage with a score below 580.)

Waiting periods apply if you have had a bankruptcy or foreclosure. Most lenders won’t offer you better rates until a bankruptcy is four years behind you and it has been at least two since a foreclosure. In order to qualify for a FHA loan, you have to be at least two years away from a foreclosure, and you can get a loan with as little as a 3.5% down payment.

Improving Your Credit to Buy a Home

So what should you do if you don’t have any recent bankruptcies or foreclosures and would like to buy a home but have bad credit?  Your first move should be to try and improve your credit score. Here are three ways to begin improving your credit score:

1. Make your payments on time and in full.
2. Pay down your debt, reducing your debt to income ratio.
3. Avoid applying for very much new credit.

One way to build a history of making regular payments is with a credit card, but you may not qualify for one if you have bad credit.  One option is to open a secured credit card, where lenders are willing to give you a credit card if you provide collateral in case you don’t make your payments.

As long as you use it responsibly, making regular purchases and paying down the balance each month, this can be a fast way to help your credit score.

Other things that can help you improve your qualifications for a home loan include:

Earn a regular wage. Self-employment offers a different challenge. If you are self-employed, you should be able to show tax documentation of regular earnings. However, self-employment income isn’t going to be viewed by lenders as favorably as a salary. Show that you have been steadily employed for at least a year or two.

Save up for a down payment. If you have poor credit, you can improve your chances with a down payment of at least 10%. If your credit score is lower, approaching 600 or below, you might need 20% down. If you have a credit score of less than 500, there is a good chance that you will need a 35% down payment to qualify.

Letter of explanation: If you have a compelling explanation for your low credit score, a letter of explanation might be required. You can explain extenuating circumstances (such as job loss or medical catastrophe) that led to your poor credit. You can also describe what you are doing to improve your financial situation.

When you have bad credit, it is still possible to buy a house. However, you will need to work hard to improve your credit score at least a little, and you may have a couple other hoops to jump through.

As banks look for more ways to make safe lending decisions, they’ll continue to add new criteria that help them make better decisions. If you’re feeling like it’s hard to juggle all the different factors that go into your score, I thought I’d share a few things that are immune to the FICO credit scoring calculations.

According to the myFICO website, these factors aren’t considered when determining your score:

1) Demographics Prohibited by Law
The Equal Credit Reporting Act makes it against the law for credit bureaus to factor the following into your credit score – race, religion, gender, nationality, marital status, and age.

If I had to guess, I imagine that companies would like to be able to look at these factors.  If you analyze data based on these criteria it’s possible you could see patterns based on some of those factors. Their models are complex and involve lots of variables so it’s not like any one of these things would make or break your score, just feed into their calculations. If they were able to find information they thought was predictive of your borrowing risk I imagine they’d use them.

However, the Equal Credit Reporting Act prohibits them from using those factors.

2) Your Age
Using your age as a factor is one of the things not allowed by the Equal Credit Reporting Act but I thought it deserved a closer look. Although your age isn’t factored into your score, it can indirectly have an impact if you’re young and just getting started in life.  If you don’t have any credit history at all it will hurt your score, no matter how old you are. 

But many people that don’t have credit history are just starting off in life. So if you’re young and your credit report doesn’t show any record of you borrowing and paying back money it can hurt your credit score.  If that’s you, check out this article on how to use secured credit to build your credit history.

3) Employment Information
If someone wanted to borrow a lot of money from you what’s one of the first things you’d ask them?  You’d probably want to know how they planned to pay it back.  If they didn’t have a job, or some way to generate income, would you want to lend them the money?

Well your FICO score doesn’t look at whether you have a job, how much you make, who you work for, how long you’ve had a job, or the various places you’ve worked in the past.

However, even though it’s not part of your credit score, if you’re looking to borrow money, the lender will certainly ask you to verify your income.  So if your FICO score is amazing but you just lost your job and have no income, would they still lend to you?  I guess it depends on the situation but maybe not – which is why it’s smart to have an emergency fund.

4) Where You Live
The city and neighborhood you live in don’t have any direct impact on your credit score.  However, if you took out a mortgage to buy the property you live in then where you live has an indirect effect.  If you had to take out an enormous loan to buy your home that will show up on your credit report and lenders will take this into account when they examine your debt to income ratio.

5) Current Interest Rates
If you’re paying really high interest on a loan or credit card you may be trying to raise your credit score so you can lower your interest payments.  The good news is – the fact you’re currently paying high interest rates doesn’t impact your credit score.  However, if you open a new line of credit at a lower rate, like a balance transfer credit card, that will show up on your credit report and will affect your credit score.

6) Non Loan Application Inquiries
Your credit can be accessed for reasons other than you applying for a loan. For example, if you just want to check your credit to see where it stands, that doesn’t count against you. Here’s a list of inquires that shouldn’t impact your credit:

• Requests you make for your credit report, in order to check it
• Requests from lenders for “pre-approved” offers
• Requests from lenders for account review
• Requests from employers

7) Other
Here are the remainging items that round out the list of things that shouldn’t raise or lower your credit score:

• Child Support Payments
• Rental Agreements
• Data not on your credit report
• Credit Counseling Status

So if you’re feeling uncertain about what criteria impact your score and in what way, at least you know a few things you don’t have to worry about. You can also check out the 12 steps to improving your credit to get a mix of short term tactics you can use plus longer term strategies for raising your credit score.

Credit Score Strategy & Tactics

The best long term way to improve your credit score is to make regular timely payments and keep your balances low.  This is a good strategy regardless of whether you’re trying to raise your credit or just be smart with your money.  If you follow this approach year after year then your credit should be pretty solid.

However, there are certain factors that play a big role in your credit score and it does help to pay extra attention to them.  This is where credit score tactics come into play.  If you understand a few key things to watch out for, they can pay off nicely with an even higher credit score, we’ll go through them in a minute.

Of course, if you have bad credit and need to borrow money quickly at the lowest possible rate then the tactics can help you get somewhat of a score boost right out of the gate.

Credit Score Steps

I wrote recently about why a low credit score can be a problem and the factors you can work on to improve your credit score.  I mentioned that David Bach included a series of steps in his book that he recommends for raising your credit score.  Today I’ll finish out my look at “Debt Free for Life” by going over those steps and hopefully you’ll have a good basis for getting your credit score on track.

Why 12 Steps?

The negative to anything that takes 12 steps is that you could be overwhelmed by the idea of 12 things to do and not even start.  If that’s the case, I understand how you feel. 

The time rationing part of your brain might prioritize it to the back of the list.  You think, “12 steps – no time for that right now.  I’ll get to it when I have some free time”.  Of course the problem becomes that block of time never actually frees up.

Another way of looking at it, is that you only have to do one step at a time.  So, if it makes it easier to get started, you could call it a flexible 2 step program.  First do 1 step, then when you’re ready check the list for the next step.  Take as long as you want, keep going until the list is done.

Whatever mental approach works best for you, here are the things Bach recommends you do to raise your score.

1) Check Credit Report Errors 
Read the post on improving your credit score to see how issues with your credit report can impact your credit score and how you can correct them.

2) Automate Bill Pay 
I use online billpay to automate our payments and agree that it almost eliminates late payments.  Since your payment history is the biggest factors in determining your credit score, it makes sense to be sure your payments are sent.

3) Pay Off Missed Payments 
The bad news is that missed payments stick around on your credit history for 7 years.  The good news is that their negative impact decreases over time, so the sooner you pay off outstanding debt, the better it is for your credit score.

4) Keep Your Balance Far Below Your Credit Limit 
Bach uses the example of having a $1,000 balance on a card with a $2000 credit limit.  If your company suddenly cuts your limit in half, then you’re maxed out on your credit utilization on that card and that hurts your credit score.

5) Beware Continual Balance Transfers
Bach recommends against continually opening new balance transfer cards and moving your balance from card to card. He doesn’t explain the logic behind it but apparently having mutiple small balances on several cards is better for your credit score than consolidating all your expenses into one big one credit card balance.

6) Big Spender? Pay Off Early 
If you spend a lot on your card you can make payments before the end of your statement period to help your credit. That’s because the credit card companies report the Amount you owe to the credit bureaus at the end of your statement period.  Even if you pay off your card every month, those agencies are going to see high levels of credit utilization.  Paying off your balance a few days before your statement period helps keep the amount reported to Equifax, Experian, and TransUnion lower.

7) Don’t Close Old Accounts 
If you close old credit accounts it shortens your potential credit history and reduces the total credit available to you – both of which can be detrimental to your credit score. 

8 ) Use Old Cards Occasionally
Banks have been known to close inactive cards.  The impact of the bank closing your card is the same as if you closed the account – it has the same drawbacks that we just discussed above.

9) Show Responsibility 
This one falls under the credit score strategy I described earlier. It’s not a tactic as much as it is an approach to money.  Make sure you don’t borrow too much and pay back what you borrow on time. Only open new accounts when you need them.

10) Strategic Loan Applications
When you’re applying for a car loan or home loan, if you’re going to apply with more than one lender, do it all at once rather than spreading it out over months.  Each of those applications shows up on your credit report. Lots of those inquiries over time could indicate you’re trying to borrow money from multple places, which could mean you’re strapped for cash.  According to Bach, the FICO scoring system is setup to treat multiple loan applications in a short period of time as acceptable, to handle cases like applying with multiple lenders for a home loan.  If you spread out the applications over more than a month it could impact your credit score.

11) Limit “Hard Inquires”
When you check your own credit it shows up on your credit report as a “soft inquiry”, meaning that your credit wasn’t being checked with the purpose of lending you money.  In contrast, when you apply for a loan or line of credit, that creates a “hard inquiry” or a “hard pull” and the credit reporting agencies hold too many of these against you when calculating your credit score.  Make sure you understand the differnce between a soft and hard inquiry, and limit the hard pulls.

12) 3 in 1 Reports & Credit Monitoring
Bach thinks it’s worth your money to sign up for a 3 in 1 report that shows your credit scores from all three major credit burueas and also provides you with identity monitoring.  Based on all the things we’ve covered in the last few credit posts, he feels like your credit score is important enough that the cost of the report and monitoring is more than paid for by the benefits of knowing your score and being able to keep it an eye on it.

Improving Your Credit Score

Bach’s suggestions fall into three main types of categories: information gathering, credit tactics, and credit strategy.

Information Gathering

Information gathering are things like getting a 3 in 1 report, checking your credit report for errors, and using credit monitoring.  They let you know where you stand from a credit score perspective and help you keep an eye on your score.

Credit Tactics

Other recommendations are tactics – such as keeping old accounts open, submitting all your loan applications within a short timeframe, and paying off big balances before your statement period ends.  They’re all based on a knowledge of how your credit score is calculated and following those tips can keep you from getting negative marks that lower your credit score.

In reality they have nothing to do with the health of your finances but it’s good to know about them and make use of them to keep your score higher.

Credit Strategies

The last set of recommendations are more strategic approaches, like automating your bill pay and responsible use of credit.  These help you create long term habits that not only help your credit score, but also help your finances as a whole.

Any of these individually are good steps to take and can help you make progress towards raising your credit score.  The real benefit comes from combining all of these approaches together, do that and you can really see your credit score go up.

The following chapter of “Debt Free for Life” goes into detail about things you can do over time to improve your credit score – and as a result, pay less interest.  He starts off by covering your credit report and how it determines your credit score.

Credit Report to Credit Score

Your credit report contains identifying information about who you are, a list of all your credit accounts,  credit inquiries made on your SSN, and any collection activity like foreclosures, liens, or bankruptcies.  The role of the credit scoring agencies (Equifax, Experian, TransUnion) is to analyze all this data and use it to determine how big of a credit risk you are.

They sift through all your data with mathmatical formulas that compare the specifics of your situation to all the information, history, and assumptions they have about borrowers. The end result is a number that’s supposed to take into account everything on your credit report and define how safe, or risky, it would be to lend you money – that number is your credit score.

So basically your credit report is all the data about you and your credit score is a summary of that information that lenders use to decide whether to lend to you and at what terms.  Since all the data on your credit report helps make up your credit score, Bach’s book points out how an error on your credit report can potentially hurt your credit score.

Bad Credit Report Data

Bach cites studies that have shown a surprsingly high number of people who have errors on their report, so he suggests the first thing you should do when trying to improve your credit score is check your credit report for any errors.

The Fair Credit Reporting Act (FCRA) can help you out in two different ways.  One thing it does it require the credit bureaus to give you one free copy of your credit report each year, which you can find at annualcreditreport.com.  

Example Credit Letter

Another thing the FCRA does is require that inaccurate information on your report be corrected if you can prove that it’s wrong.

After you send in a request to a credit bureau to correct your information they have 30 days to respond back.  Another important point that Bach mentions is that you have to fix any errors separately with each different credit bureau.

His book gives you a form you can use to ask a bureau to fix your credit report and also provides the addresses where you can send your request for Equifax, Experian, and TransUnion.

Why a Good Credit Score Matters

As I mentioned the intent behind your credit score is supposed to be a standard gauge to help lenders decide whether to lend you money, how much, and at what interest rate.

What Bach brings up is that your credit score is now being used for more than just lending decisions.  I don’t have any exeperience with this but there are cases where credit scores are used when making hiring decisions and evaluating you for insurance coverage.

One example he gives in his book is that in the military, soldiers with poor credit scores could be passed up for promotion because the bad score might represent a security risk.  I don’t have any data on how widely credit scores are being used for things other than lending decisions but if it becomes more widespread then your credit score could influence more than just you borrowing money.

Should You Care About Your Credit Score?

I’ve had people complain on this site that the whole credit scoring system is out of control.  For example, they think it’s ridiculous that college students or young professionals should borrow money just to build a credit history.  The obvious fear is that you create debt, or a habit of borrowing, just so you can prove to the system you’re not a risky borrower.

I agree it does seem silly to borrow money when you don’t need to, promoting borrowing, instead of saving.  However, I don’t think it’s something that you can ignore simply because you don’t agree with the system. Everyone who wants to borrow money will be compared to millions of other people by the credit scoring models.  Good or bad, right or wrong, the credit scoring system is how lending decisions are made in the US.

The longer you don’t acknowledge it’s importance and avoid taking steps to build a credit history, the more difficult it might be to borrow money when you need it someday.  It takes time to build up a credit history so it’s better to start when you don’t actually need the money and do it gradually over the years, rather than wait until you really need the money and time isn’t on your side.

Bad Credit Scores

Halfway through the chapter on your credit score, Bach highlights the fact that last year FICO announced about 25% of US adults had credit scores below 600.

This is a big deal because a score below 600 makes it difficult for you to get approved for a credit card, car loan, or home loan.  I imagine many of the people that fell below 600 had some sort of financial complication caused by the “Great Recession” of the last few years.

The reasons he highlights the big drop in credit scores in the book is to demonstrate how your credit score can change over time.  The median credit score in the US is estimated at 720 and it could be that some of the people who dipped below 600 at one point had a score of 720 or better.

The scary thing about your credit score is that the time you most desparately need to borrow money could be when your credit score is at it’s lowest. So if you have a good credit score but then lose your job and your house and can’t pay your bills, your lenders will inform the credit bureaus and your credit score will fall.

I think the important lesson here is to think twice before depending on something like a home equity line of credit for your emergency fund.  If your financial life has a melt-down it can take that emergency fund with it, as well as your credit score.  At that point, you’ll be really glad if you saved up an emergency fund to help you get back on your feet.

Good Credit Scores

Now that we’ve covered why you have to watch out for a bad credit score, let’s look at what you need in order to have a good credit score.  FICO lists the different credit score factors on it’s website, Bach discusses each of those compenents in his book and gives example of what to consider for each.

Each factor has a different weight and the ones that make the most sense are the ones that make up the biggest portion of your score.  The top three are your payment history (35%), amounts you owe (30%), and your length of credit history (15%).  These make sense, lenders want to know what you’ve done with your loans in the past, how much you owe right now, and how much experience you’ve had with borrowing and repaying loans.

The other two factors are how much new credit you’ve opened recently (10%) and the different types of credit (10%) that you currently have.  New credit applications make sense because they want to know if you’re scrambling to borrow a bunch of money. Of course, another scenario could be that you got a much higher paying job and can afford to borrow more – something your credit score won’t tell them.

In terms of the different types of credit you use, apparently a bigger variety of credit can benefit this portion of the score.  Not only that, having only one type of credit can actually hurt your credit score.  I don’t really understand the logic behind this part of the criteria so I can’t explain why it works that way.

Negative Credit Score Factors

Bach points out some helpful research done by Liz Weston that gives insight into what actions can really hurt your FICO score. She talked FICO into giving her an estimate of how the following things impact your credit score:

• Maxing out your credit card
• Skipping a payment
• Debt settlements (ex: short sale)
• Foreclosure
• Bankruptcy

He goes into more detail about each of them and the potential number of points each could drop your credit score.

The Cost of a Bad Credit Score

Bach ends the chapter with a 12 step action plan to improve your credit but right before he digs into the action plan there’s a section on how much money your credit score can save you, or cost you, when applying for a loan.

I’ve talked before about what a good credit score is worth and how your credit score affects interest rates when applying for a home loan. The book has a table that shows an estimate of what your interest rate and monthly payment would be based on your credit score range.  According to the table a drop of 130 points in your credit score could mean an extra $300 a month in mortgage payments.

If nothing else, that kind of savings should be a good motivator to do what you can to improve your credit score.  If this article left you with any questions about your credit score, please ask them in the comments below. Next time I’ll go over Bach’s action plan for fixing your credit.

I’ve never personally dealt with carrying around debt on my credit card but said I’d be willing to check out his advice when Bach’s team asked me to review that part of his book.  The previous chapters talked about organizing and prioritizing your debt  – at this point in the book, the emphasis is on reducing the amount of interest you’re paying on your card or cards.

Finding the Best Interest Rates

The approach he suggests is one of negotiation, and in any negotiation it always helps to enter into it with as much information as possible.  The main idea is that you’re likely paying more interest than you could be so you should compare yourself against people around the country to see how much room there is to negotiate.

The book gives you a worksheet to track the balance and rates on each card and the progress of your negotiations.  Bach suggests finding out right away what rate new customers are paying on the same card that you have.   Then he breaks down the different interest rate categories based on your FICO score :

1. Super-Prime
2. Prime
3. Sub-Prime
4. Punitive
5. Promotional

His chart shows you which category you’d fall under and what interest rate you should expect to pay – based on your credit score.  Obviously if there’s a big gap that can be a talking point when you call up the credit card company.

Your Credit Score

If you don’t know your credit score, Bach recommends trying out a program from Equifax called DebtWise.  In an earlier chapter he explains how he came across the tool and worked with Equifax to add features that basically took the system he’s been teaching for paying off credit card debt and automates all the steps. 

Anyone who buys his “Debt Free for Life” book gets a DebtWise free trial for one month – I’ve never used the service but I agree that free is good.  Similar to other free credit score options available, if you remain a customer after the trial the service has a monthly fee.

Negotiating Your Debt

Once you know your credit score, what interest rate your score should qualify you for, and the interest rate being given to new customers you have enough information to begin negotiating.  Bach gives you several strategies for overcoming common obstacles when negotiating your interest rates.

There’s not a lot that Bach writes about that you couldn’t eventually figure out on your own but his tips can definitely save you time – and when you’re paying high interest rates time is money.   Bach’s big advantage is that he’s worked with thousands of people to get out of debt in his career so he’s seen what tends to work and what doesn’t.

In my opinion, the best feature of the book are all the examples he gives of former clients and what did, or didn’t work for them. Since I tend to learn better through examples and stories, I think these are the most useful parts of his book. I remember reading about Bach’s Latte Factor concept in his book “Smart Couples Finish Rich” right after my wife and I were married.  Some of the tales he shared of his former clients still stick with me to this day – so pay attention to those sections and learn from the experiences of others so you don’t make the same mistakes yourself.

One of his stories in this book explains how a client went through all his steps and was able to lower their interest rate.  However, it wasn’t as low as they’d like so she ended up signing up for a balance transfer card that gave her 0% interest on her balance for 6 months while she worked on paying it off.  I think this is a good example of how there’s no one right way to accomplish your finance goals – and sometimes you have to try several different things to find the best one for you.

Forbearance & Debt Management Plans

If negotiation doesn’t get your rate lowered and you’re really struggling because you lost your job, were injured, or are just earning less – then you can talk to your credit card company about restructuring your debt.  These are cases where companies are willing to work with you because your ability to pay back the money you owe has been dealt a major blow. 

Since this sometimes involves drastically lowering your interest rates and minimum payments, the credit card company does their homework to make sure you really have suffered a hardship and aren’t just trying to get out of money you agreed to pay.

The book explains how Forbearance and Debt Management Plans work and things you should be aware of before deciding to take that approach (such as frozen credit and damage to your credit score).  He also discusses alternatives to these strategies, such as credit counseling, and devotes a chapter later in the book to the topic.

Improving Your Credit

When it comes to your credit score, the saying “the rich get richer” seems to apply to the whole system.  People who have high debt to income ratios and a long history of good credit can borrow money at the lowest interest rates.  Of course, these are the people who probably have the least need to borrow money – in contrast to consumers with bad credit and high debt levels who are more likely to run into desparate times and need access to credit.

Once you’re in debt it can be tough to improve your credit score in order to borrow at lower rates. Next week I’ll cover another chapter in Bach’s book that explains how your credit score works and different ways you can raise it.

Changes being made to scoring models, as well as inclusions of non-credit data in your credit report, might help financial service providers get a more accurate picture of what sort of credit risk you really are.

Experian to Start Tracking Rent Payments
One of the major credit bureaus, Experian, has announced that it will start tracking rent payments. Those who make regular rent payments are not being recognized for their financially responsible behaviors.

Even though landlords can report them to credit bureaus when they are late paying, or skip a payment, there has not been a system in place to report on time payments. This is changing with Experian’s RentBureau. Positive rent data could be a help to a consumer who is responsible, but who doesn’t have mortgage payment to help boost his or her credit profile.

FICO Expansion Score
In addition to being the foremost in credit scoring, FICO is also trying to widen its range offerings when it comes to consumer credit behavior. The company now offers the Expansion Score. The FICO Expansion Score factors in such items as rent payments, utility payments and other regular bills. This product also manages your checking account, so a bounced check can reflect on your consumer credit profile.

PRBC Reporting Agency
If you are interested in a credit reporting agency that focuses on non-traditional indicators of fiscal responsibility, you can consider the PRBC reporting agency. This agency collects information on bill payments, rent payments and more, and uses it to put together consumer credit reports.

PRBC makes use of the FICO Expansion score as well. However, you will have to request that the companies you work with report your good payment habits to PRBC; it doesn’t just happen.

FICO 8
On top of consumer credit profiles including information that isn’t normally considered to be “credit related”, it is worth noting that FICO has been tweaking its formula. FICO 8 is gaining popularity (even though it was released nearly two years ago), and it contains some new items that can help you improve your credit score.

Instead of penalizing you heavily for one-time missed payments, the new FICO score takes into account the fact that isolated late payments happen. If you have a generally good payment history, one missed payment won’t damage your credit score as much (although there will still be some damage done).

Additionally, FICO 8 will no longer take into account small collections. If the original balance was $100 on a bill that goes to collections, the new credit scoring model will disregard it. This should help consumers who might have forgotten about a small bill, or if a payment falls through a crack. FICO 8 is more forgiving in some ways.

Of course, some of the tweaks to FICO 8 will hurt consumer credit scores. The main downside to FICO 8 is that high amounts of debt can be more damaging. If you are close to maxing out your credit cards, it will have more of a negative impact on your credit score.

In the end, the quest is to reduce your financial habits down to an accurate number. In order to do that, credit agencies and credit scoring model developers seek to include more information.

myFICO & Your Score

You probably already know that your FICO score is the credit score that many lenders — and even some insurance agents and employers — use to determine what sort of financial risk you represent. Variations of the FICO score are used in a number of ways to determine approval and rates for your mortgage, car loans, and credit cards.  However, the FICO score is used by 90% of the largest banks and 100 of the top 100 U.S. credit card issuers so it’s the heavy hitter when it comes to credit scores.

myFICO Standard

At the most basic level you get your FICO score, plus receive an explanation about what it means and an idea of how lenders view you.

You can choose to see your FICO score from either TransUnion or Equifax, Experian no longer participates.  FICO standard also includes a credit report from TransUnion or Equifax, whichever FICO score you choose – your score will likely vary somewhat across credit bureaus.

The FICO Standard score and report is $19.95, but as mentioned earlier you can see your credit score and credit report at no charge if you sign up for a free trial of ScoreWatch.

myFICO ScoreWatch

ScoreWatch allows you to get two FICO scores and two credit reports from Equifax each year, and it keeps tabs on changes to your credit score.

If you’re looking for the trending of your FICO score rather than just a snapshot then Scorewatch can be useful.  For example, if you’re trying to improve your credit score and want to see progress, ScoreWatch gives you a graph of your score over time as well as regular updates:

• Monitors Equifax credit report daily & FICO score weekly
• Target credit score notifications
• Notifications when you qualify for a better interest rate
• FICO score drop alerts due to changes in your credit report

Check out ScoreWatch

FICO Quarterly Monitoring

If you’re not actively tracking your credit score but want to check in on it a few times a year, FICO Quarterly monitoring can help you keep tabs on your score.  

As you may know you’re able to get a free credit report every year from each credit bureau from annualcreditreport.com.  This service uses TransUnion and makes your credit report and credit score available every quarter.  The one extra credit report you get from the myFICO service is nice but you might not really feel like you need it.  The main benefit of this service is that you get your credit score in addition to your credit report.

So every three months you receive a score and report, and an explanation of the positive and negative items affecting your score. You can identify problem accounts, as well as look for ways to improve your credit situation. The Quarterly Monitoring service will also alert you to changes in your credit score.

In the event that the change was due to identity theft, myFICO’s Quarterly Monitoring also provides identity theft insurance for up to $25,000 and a hotline to help you file id theft reports and complaints.

Suze Orman’s FICO Kit

While ScoreWatch and Quarterly Monitoring are setup to keep track of your credit score over time, the Suze Orman FICO kit is designed to walk you through the steps to help improve your credit.  Created along with personal finance author Suze Orman, there’s more coaching and what-if analysis in the FICO kit.

Suze Orman’s FICO Kit gives you three credit reports and scores a year. The kit also includes the FICO Kit Action Planner that helps you take the information in your credit report and plan out steps to improve your score.

You can tailor the tool to your personal situation with their tools like the debt eliminator, bill pay reminders, and online coaching to help you get a car loan or home loan are included. You can also use the FICO Simulator, which allows you to estimate the effect certain changes would have your score.

You can use this myFICO promo code to get a discount on the FICO kit – SUZEFKP