Credit Scores – Importance and Common Mistakes

Credit Scores-Why are they important?

Credit scores are very important especially when you are looking to purchase a home.  A credit score is a number that helps lenders predict how likely you are to make your credit payments on time.  A good credit score can determine how much interest you pay or how much of a deposit you’re going to have to pay. 

What is a good score?

Credit ratings are based on a scale from 300-850 and the higher the score, the better.  Your “score” refers to the FICO score developed by Fair Isaac Corporation.  Most people score in the 600’s and 700’s.   Lenders buy your FICO score from three credit agencies: Equifax, Experian and TransUnion.  A score above 700 is considered very good and anything less than 600 is considered risky. 

How a good credit score can impact your bottom line

Let’s say a couple is looking to buy their first house and they are interested in a thirty-year mortgage loan.  If their credit score is 720 they could qualify for a mortgage with a low 5.5% interest rate.  If their scores were 580, they probably would pay 8.5% or more, costing them more than $2400 a year on a $100,000 mortgage loan.  That would add up to $72,000 over the 30 year life of the mortgage!

Credit mistakes that could lower your score

Paying bills late – Don’t make the mistake of consistently paying your bills late.  Too many late payments get reported to the credit bureaus and will have a negative impact on your credit score.

Not Paying At Least the Minimum Amount – Aside from being expensive due to interest and late fees, not paying at least the minimum amount due will eventually report your account as past due and adversely affect your credit rating. 

Having Too Many Credit Cards – Frequently we receive tempting offers to take out additional cards.  Having too many cards (even if some are inactive) signal that eventually you may not have enough income to pay them.  If you have inactive cards the best thing to do is close them.  Having fewer accounts means it’s easier for you to track and improve your chances, in the long term of a better credit rating.  In the short term, however, closing accounts may cause your rating to drop, as you will then have high credit balances spread out over a smaller overall credit account base.  But for the best financial health, closing cards you don’t use it advantageous.

Having Too Many Lenders View Your Credit Report – Every time you apply for credit, your credit report is viewed by the lender.  The more times potential lenders pull up your credit report may indicate that you are applying for credit from various sources and taking on too much debt.  If you are shopping for credit, do it within a short period of time (a few days) so that it will appear to be one big inquiry rather than several.

Not Alerting Credit Card Companies of Relocation or Name Changes – When you don’t alert your creditors about a relocation, you risk the chance of your bills not arriving on time and payments being late. And, when creditors are not notified of a name change, you risk the chance for inaccuracy on your report.

Thinking You Only Have One Credit Score – We all have several credit scores or ratings—and they can vary widely.  Not only are there the Big 3 listed above, but there are also various smaller credit bureau companies.  Plus, some larger lenders calculate their own credit scores.  Minimally, you should contact the three major ones and handle them separately to clarify or repair your credit score.  

The good news about credit scoring

Credit scores today give lenders a fast, objective look at whether or not someone is a good credit risk.  For you as a prospective home buyer, the process of securing a loan is much quicker and fairer.  If you have had credit problems in the past, they now don’t follow you for the rest of your life.  And, thanks to credit scoring, even people who have been considered a risk in the past can frequently still borrow within certain guidelines.

The more credit that is available, the cheaper it is to borrow.  The whole system makes borrowing much more efficient and cost effective.  Mortgage rates are lower in the United States than in Europe, for example, in part because of the information that is now available to lenders here.