Understanding Your Credit Score

By Bryan M. Kuderna, CFP®, RICP®, LUTCF On Dec 30, 2019

Many people struggle with the concept of a credit score, often ignoring its existence until it matters.  Then it seems to be all that matters.  An individual’s credit score is a three-digit number that ranks his or her ability to repay debt.  Why should anyone care?  In the 1980’s credit scores became commercially available, and then in the 1990’s Fannie Mae and Freddie Mac informed mortgage brokers and lenders that credit scores needed to be a part of the mortgage decision process. Today there are billions of data pieces collected from over 13,000 different sources.  Any time that money is wanted, the corresponding lender will first ask, “What’s your credit score?”

Why Do I Have Different Scores?

To muddy the waters before we separate fact from fiction, one must note that there is more than one credit score.  The three main credit bureaus are Equifax, Experian, and TransUnion.  They typically use a range of scores from 300-850.  These companies can provide different scores because of unique methodology combined with the fact that many lenders report their customer information to some bureaus and not others.  In other words, one bureau might be aware of a late payment on an old store credit card where perhaps another is not.

These three major credit reporting companies collaborated to create Vantagescore in 2006 in an effort to simplify matters.  There are also FICO scores, created by the Fair Isaac Corporation.  The Federal Housing Finance Agency (FHFA) has established a process in which no single brand is allowed exclusive right to be used by lenders. So, expect to see these variety of scores and reporting agencies to continue.

How’s My Credit?

According to most major rating bureaus, 300-579 is considered Poor, 580-669 is Fair, 670-739 is Good, 740-799 is Very Good, and 800-850 is Exceptional.  According to Experian, 67% of Americans have a Good FICO score or better.

The factors that dictate this score typically include payment history of loans and credit cards (including any late payments and their severity), credit utilization rate, number of and age of credit accounts, total debt, public records such as bankruptcy, how many credit accounts have recently been opened, and number of inquiries for your credit report.  Credit utilization is a commonly confused metric that measures revolving credit, which is debt that does not have a pre-determined end date, such as a credit card.  It is equal to outstanding debt versus total available credit.

Simply checking your credit score does not hurt them, it’s considered a “soft inquiry” which is not factored into calculations.

Ways to Improve a Credit Score

After a credit score is pulled, the company will offer “reason codes” which explain why the credit score is not higher.  Naturally, they’ll be relevant to the aforementioned factors.  The most obvious ways to improve a credit score are to pay all bills on time, apply for credit only when necessary (this may have a positive impact on credit utilization as more credit is available, but temporarily negative as more accounts are opened), keep outstanding balances low (FICO and Vantagescore always recommend keeping below 30%), hold open accounts for long periods of time, or use different types of loan products (i.e. credit card, car loan, mortgage, etc.).  As far as how long it takes to repair credit, most delinquencies last for seven years, public records for ten years, and inquiries for two years.

A common complaint amongst millennials is the impression that no credit equates to bad credit.  Some quick fixes to a “thin credit file” are to apply for a secure credit card (works like a normal credit card but requires a refundable security deposit), become an authorized user on another creditworthy individual’s account, apply for a credit builder loan through your bank, and ask for rent payments to be reported to credit agencies.

Frozen credit can lead to financial disaster for individuals, households, businesses, banks, and even countries.  Be sure to keep this lifeblood of finance flowing smoothly by understanding how the most important of scorecards works.

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