WHAT’S IN A NUMBER?

 

Your credit scores is a statistical calculation used to determine personal credit-worthiness. Many of us wonder…how do they determine this number?  Who does it? And what does it REALLY mean in the larger spectrum?   Here you go!!

The most common credit score is the FICO score. This acronym was generated from software developer Fair Isaac and Corporation.  Three major credit reporting agencies, Experian, Trans Union and Equifax, provide FICO scores to lenders to help them assess “risk” when a potential customer applies for financing.

While many people strive to achieve the highest credit score possible, few will earn a perfect score of 850. A person’s credit score affects their ability to qualify for various types of credit and also determines the interest rates tied to those types of credit. For example, based on national averages in December 2010, a homeowner applying for a $200,000, 30-year fixed mortgage with a credit score between 760 and 850, may receive a 4.353% Annual Percentage Rate (APR), resulting in monthly payments of $996. However, the same loan for a person with a lower credit score, say between 620 and 639, would result in a 5.942% APR, or $1,192 per month. Over the life of the loan, the person with the higher credit score would save approximately $70,000 in interest.

Credit Score Calculations
Credit scores range from 300 to 850. According to MyFICO.com, approximately 13% of FICO credit scores exceed 800. Only 1% of consumers achieve a perfect score of 850. In general, the higher the score, the lower the risk to a potential lender.  Five factors are included and weighted in calculating a person’s credit score:

* 35% is based on your Payment History.
* 30% is based on Credit Utilization.
* 15% is based on the Length of Credit History.
* 10% is based on New Credit.
* 10% is based on Types of Credit Used.

The One Percent
Many people have excellent credit scores, but a perfect score of 850 is difficult to earn. So, what are 1% of Americans doing differently than the other 99%? Those individuals who achieve the 850 score are often actively and consciously trying to do so. Here are some tips to help you improve your credit rating FICO score:

  • Pay bills on time.  Paying every bill on time is important to maintaining a high credit score. From credit cards to mortgages to medical bills, even one late payment can impact your credit score dramatically.
    Typically, a perfect credit score will reflect zero late payments in the last seven years.
  • Use only a fraction of your available credit.  In general, the less credit you are using, the better. Ideally, aim to use only 10-20% or less of your available credit each month. Thirty percent of your credit score is based on credit use, the ratio of your debt to your credit limit. The higher the number, the lower the credit score. People with perfect scores usually have a low utilization rate of less than 10%. To help maintain a higher available balance, do not close credit cards you don’t use. Keep them open so that balance shows as available.
  • Review your own credit report.  Looking at your personal credit report will not negatively impact your credit score. Consumers are entitled to at least one free credit report each year from one of the three major credit bureaus. It is wise to review the report for any errors. Look for incorrect credit limits and delinquencies which could be reconciled.
  • Manage your credit card “quiver”.  Having a large number of credit cards makes you appear desperate for credit. You can be penalized for having multiple large balances. It is much better to have only a few credit cards
    with the bulk of spending placed on one card. Many credit issuers will automatically close inactive credit cards. It is a good idea to make small charges every few months on the lesser-used card(s) to keep the account open.
  • Diversify your credit.  Having multiple types of credit is a plus when it comes to your credit score. A consumer having a variety of debt types may be considered financially responsible, assuming the payments are being made on time. Credit cards, mortgages, automobile loans and retail accounts in good standing can increase your credit score. But, having too many credit accounts can also detract from your score. How many accounts
    does the perfect credit holder possess? Typically, SIX accounts.
  • Wait for it.  It takes time to build credit and even more time to get a perfect credit score. Ten years of positive account history is generally needed to score above 800. Generally, people achieving perfect scores opened their first accounts 20 years earlier.

Is Being Perfect Worth The Effort?
So, is striving to achieve a perfect credit score of 850 really worth it? In general, no. Consumers with perfect scores will not have access to better loan rates than those with scores in the upper 700s to low 800s. In fact, when it comes to mortgage rates, the best APRs are awarded to those in the 760 to 850 range. So, in reality, there may be little financial reward for reaching 850.

The Bottom Line
You may be wondering if a perfect score of 850 is even possible to achieve. For most people, the answer is probably not. Those who do earn an 850 are committed to the cause. They actively evaluate and control all aspects of their finances. A more realistic credit score in the high 700s will likely land consumers the same advantages as the perfect score of 850. What a relief since making reaching that 1% is a pretty daunting task!

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