Paying bills on time, and returning your library books, can improve a key credit number.
By Kimberly Lankford, Kiplinger's | March 2006
Pop Quiz: Which affects your credit score more, getting married or having overdue library books?
Surprise answer: A library fine that goes to collection can shave 100 points off your credit score -- and boost your annual interest payments by hundreds of dollars. But getting married doesn't affect your score at all unless you co-sign for a loan with your new spouse.
Your credit score -- the numerical summary of how much you owe and how promptly you pay your bills -- has a major impact on your finances and beyond. Score high and you can save thousands of dollars on your mortgage, car loan and credit cards.
A good score can also reduce your premiums for auto, homeowners and private mortgage insurance. Auto insurers use credit scores to assess your risk of getting into an accident because studies show that consumers with high scores tend to file fewer claims.
On the other hand, a low score can make it tough to not only get a loan but also to buy a cell phone, rent an apartment or get a job. It may reduce the size of the mortgage you qualify for, or require that you make a bigger security deposit when you open an account with a phone service or electric utility. "It's your GPA as an adult, " says Craig Watts, of Fair Isaac, the company that created the so-called FICO score, the most commonly used measure of credit, although not the only one (for a rundown on other scores, go to www.kiplinger.com/magazine/links).
What number should I aim for?
FICO scores range from 300 to 850, but only 13% of consumers have scores above 800. The median score is 723, and many lenders require a score of 760 or higher to get the best interest rates.
How does my credit score affect the Interest rate on a mortgage loan?
It can mean big savings -- or big penalties. Recently, for example, borrowers with a score of 760 or higher qualified for an average interest rate of 5.8% on a 30-year fixed-rate mortgage. But for borrowers with scores of 620-639, the average rate was 7.4%. That translates into $227 more each month, or $2,724 per year, on a $216,000 mortgage (see www.myfico.com for a list of average reates that correspond to each FICO score).
Your income, assets and employment, which aren't considered in your credit score, can also affect your mortgage rate and the amount of the loan. But lenders often start with a credit-score cutoff for certain rates. If the cutoff is 700 and you score is 697, you won't qualify no matter how good the rest of your file looks, says Bob Walters, chif economist at Quicken Loans.
How can I improve my score?
Read our lips: Pay your bills on time. More than one-third of your score is based on your payment history, and the later you are, the more points you lose. If you've fallen behind, pay up now. Negative items generally affect your score for up to seven years, but as time goes by their impact lessens.
How much you owe makes up another third of your score. Your "credit utilization" ratio -- the percentage of your credit limit that you've actually used -- is more important than the amount of credit to which you have access. Warts recommends keeping the balance on your cards below 25% of your available credit, or $2,500 on a card with a $10,000 ceiling. What counts is the total amount you've charged, even if you plan to pay the bill in full.
The length of your credit history accounts for 15% of your FICO score. Getting a lot of new credit within a short time span can hurt your score becaue it lowers the average age of your accounts.
About 10% of your score is based on new credit. If you open a flurry of new accounts, lenders worry that you might go on a borrowing binge. "Don't apply for new credit withing three to six months of applying for a mortgage," recommends Maxine Sweet, vice-president of consumer education for the credit bureau Experian.
Your credit report records an inquiry every time a potential lender requests a copy of the report, and that can make lenders nervous. Because more people shop online for car loans and mortgages, Fair Isaac eased its rules: If your report shows inquiries from several car or mortgage lenders within 14 days, it's assumed your shopping for a single loan. The newest version of the FICO score expands that to 45 days.
Finally, 10% of you score depends on the types of credit you use. Your experience with revolving credit, such as credit cards, on which you control how much you charge and pay off each month, carries more weight than installment debt, such as car loans and mortgages, with fixed payments.
Can closing old accounts help my score?
That's the most common misconception about credit scores. Closing old accounts can actually hurt your score because it raises your utilization ratio. Owing $5,000 looks a lot better when you have a $20,000 maximum on all of your credit cards -- a utilization ratio of 25% -- than it does when you have a limit of $7,000 -- a ratio of more than 70%.
Even though your credit score will clip temporarily, it's okay to close accounts as long as you don't plan to apply for a loan within the next few months. That will give you score time to recover. Close department store accounts and new cards first.
Can overdue library books really affect my score?
They sure can. To beef up their revenues, local governments are hiring collection agencies to track down the money people owe in library fines, unpaid parking tickets and other fees. If an account goes into colleciton, it can destroy your credit score. "That's considered a serious delinquency that could drop a high FICO socre by 100 points," says Warts.
A new version of the FICO score ignores delinquencies on accounts for which the past-due amount is less than $100. But most lenders still use the older version of the score.
If you're disputing a small charge, it might be better to pay the bill rather than continue to fight or take the issue to small-claims court. "Some consumers refuse to pay on principle, but companies that can report you to a collection agency have the power to ruin your credit," says Gerri Detweiler, credit expert for www.EverydayWeath.com and author of The Ultimate Credit Handbook. Ask to have the collection accounts removed rom your record in exchange for payment.
Will my score go down if I marry someone with a bad score?
Not necessarily. There are no joint credit reports or scores, so getting married in itself won't lower your score. But becoming a co-signer on an account with a bad history will tarnish your record. And lenders will look at both credit histories if you apply for a loan together -- and the bad one could carry more weight. See if you can qualify with only one income, or wait to apply until your spouse's score improves.
What should I do if I have a lot of black marks on my credit history?
Continue using your cards, but clean up your act. Pay your bills, keep you account balances low, and be sparing in opening new accounts. As long as you use credit conservatively, your score can rebound surprisingly quickly, says Watts. "We've seen cases of bankruptcy in which borrowers have qualified for a premium mortgage in three years."