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Improve Your Credit Score

When it comes to credit reports, there are five major areas upon which you're being judged. These major areas are:

Past payment history. Roughly 35% of your credit score is made up of your payment reliability. The more recent your lateness, the more points you forgo. Your credit report will indicate whether you are 30, 60, or 90 days or more late with a payment. A history of late payments on several accounts will cause more harm than late payments on a single account. On the other hand you can greatly improve your credit score by paying your bills consistently on time.

Amounts owed. This measurement makes up 30% of your credit score. Your amount owed is calculated by adding up all of your outstanding balances and compare the number to the amount of credit that is available to you. If you are reaching -- or exceeding -- your credit limits, lenders will be more skeptical to give you a loan. At the same time, if you aren't anywhere near maxing out your accounts, you want to make sure that the credit extended to you isn't out of proportion with your income.

Length of credit history. Roughly 15% of your credit score is determined by the length of your credit history (how long you've been using credit). The greater the length of time you have been using credit, the more favorable lenders will see you. Your score also takes into consideration how long it has been since you used your accounts. Do not open a lot of new accounts at once to establish a credit history as this will actually accect the score negatively because of the low average account age.

Amount of new credit. New credit takes on about 10% of the overall credit score. Basically every time you apply for new credit, an inquiry shows up on your report. This is a big time red flag because the lender sees that you are taking on more credit. Also note that when you are shopping for a home loan, do so in a concentrated period of time. FICO distinguishes a search for a single loan and requests for many new credit lines.

Types of credit. The remaining 10% of your credit score is based on your credit use. They want to see if you use credit cards, retail accounts, or installment loans such as car and mortgages. Just remember that when talking about credit scores, more is not always better when you are talking about credit.  On the contrary, if you have no credit, lenders will consider you a higher risk than someone who has managed credit cards responsibly.

Take Credit Now

Your credit score is a lot like your cholesterol level. A good score means you are financially healthy; a bad score means you are seriously out of shape and at high risk for some serious problems.

Even though you may have no clue what your score is, plenty of businesses you come into contact with sure know your score. Your credit score plays a big role in stuff like:

• * The interest rate you are offered on a mortgage
• * The interest rate you are offered on a car loan
• * Whether you can get a cell phone contract
• * Whether a landlord will rent to you
• * The premium on your car insurance
• * Whether a prospective employer will hire you

Your credit score tells businesses what sort of credit risk you are. With a good score, everyone is going to be happy to do business with you and offer you good credit deals.

But a bad score is a big fat warning flag for them. Businesses might still be willing to deal with you, but they’re going to be nervous enough about your ability to pay your bills on time that they are going to charge you more. It’s their insurance policy in case you do indeed turn out to be a lousy credit risk.

I am not exaggerating when I tell you that your credit score is either going to save you tens of thousands of dollars or cost you tens of thousands of dollars. So how the heck can you not know what it is? More importantly, how crazy is it not to be doing everything possible to make sure your score is as high as possible? (Be sure to check out Five Ways to Improve Your Credit Score below for tips.)

FICO Is the Way to Go
There are a handful of companies that compute credit scores, but my advice is to stick with what is known as your “FICO” Score. This is the granddaddy of credit scores, computed by Fair Isaac & Co. One FICO score costs $14.95. (You actually have three different FICO scores, which I’ll explain in a minute.) To be honest, other businesses offer cheaper credit scores, but you can’t afford to go with cheap. Here’s the deal: businesses trust FICO and use its scores when checking up on your financial health. So if a mortgage lender or car financing company is going to be checking your FICO score, you better make sure you know exactly what your FICO score is. Just because your credit score from some other business looks fine, doesn’t necessarily mean your FICO score is in good shape. And trust me, when you are applying for a mortgage, or a job, you don’t want any nasty surprises.

Go to www.myfico.com to get your FICO credit score. As I mentioned above, you actually have three FICO scores, one from each of the three major credit bureaus. (More on them in a sec.) Unless you are going to be buying a home soon, I think it is perfectly fine to spend just the $14.95 to get one report. While there are indeed some differences among the three reports, they typically fall within a reasonable range. The one caveat is if you are buying a home. Quite often, a mortgage lender will take an average of your three scores, or could even just use your lowest score to determine the interest rate you will be offered. So for prospective home buyers it makes sense to fork over the money to see all three FICO scores. The $45 bucks for all three is a small cost when compared to the size of the mortgage you will be taking out.

Typically any score above 720 is considered top-notch and will qualify you for the best deals. But in some instances lenders are going to want to see a score above 760 to snag a super offer like a zero-percent car loan. Here’s a recent breakdown of typical range categories used by lenders across the country:

And here’s what interest rate you might qualify for on a 30-year fixed-rate loan, based on these FICO score categories.

Okay, I know your eyes are beginning to glaze over, so let’s go over a real-life money scenario. Let’s see how those percentages would play out on a $200,000 mortgage. If your FICO score is 760+, you’re looking at a monthly mortgage payment of $1,126 and total interest payments over the 30 years of about $205,000. But if your FICO score is, say, in the 640-659 range you’d be looking at monthly mortgage payments of $1,260 and total interest payments of nearly $254,000. That’s a $50,000 difference over the life of the loan!

Stick with me for one more bit of math, because it’s an eye opener. The difference between the two monthly payments is $134. If you were to turn around and invest that $134 a month of mortgage savings for those same 30 years, and you earned an average annual return of 8 percent on that investment, you would have nearly $200,000 saved.

See my point? A great FICO score can translate into a huge financial windfall.

The numbers are just as compelling if you’re in the market for a new car. With a top-range FICO score you are in good shape to snag a 5.9 percent interest rate on a $20,000 four-year car loan, which will run you $469 a month. However if your score is between 625-659, the interest rate jumps to 10.8 percent and your monthly payments bump up to $515. Over the life of the loan you will pay more than $2,000 extra in interest with the higher-rate loan. Doesn’t sound like much? Come on, it’s 10 percent of your original loan amount. That’s a huge penalty, if you ask me.

Now let’s focus on what to do if your FICO score isn’t in the top range.

Read Your Report
A bit of backstory is necessary here. Your FICO score is based on all sorts of financial info that is tracked by three major credit bureaus: Equifax, Experian, and TransUnion. The credit bureaus know how many credit cards you have, whether you pay your bills on time, and all the details on any loans you might have, such as mortgages and student loans.

Sadly, though, all this access to your personal records is no guarantee of accuracy. The truth is that the credit bureaus can have faulty info on you. An old account you paid off might show up as being unpaid. Or you may find that someone has hijacked your account—the epidemic known as identity theft—and is running up credit card and loan debt in your name.

These kinds of erroneous info can send your FICO score south.

So job one is to make sure the info on your credit reports is correct. Once you clear up any mistakes, your FICO score should improve. The good news is that a new federal regulation entitles everyone to a free credit report once a year from each of the three credit bureaus. If you live in the West or Midwest, you already can get your reports for free. Everyone else will be eligible for their free reports by September1. You can check whether you live in a state that is already eligible for free reports at www.annualcreditreport.com, as well as obtain your reports there.

And here’s a neat credit report tip for the new system: you can create an ongoing free monitoring system of your credit by getting just one of the three free reports every four months. For example, start with Equifax, and then four months later get the Experian report. Then four months after that, check your TransUnion report. And you can repeat this system every year. If you find any incorrect info, follow the directions on your report to file a dispute.