Here’s a typical scenario: You and your spouse are applying for a mortgage loan. You’ve had credit for years with three or four credit cards, a car loan and a line of credit. You always pay the minimum obligation, but always on time. Your spouse, on the other hand, doesn’t use much credit, perhaps has only two or three credit lines and has an missed a payment or two in the past two years. So the lender pulls your credit report and your spouse has a higher score than you. What the ??!! It’s all in the details, my friend. Let’s shed some light on how your credit score actually gets calculated.
What is a credit report?
First off, a credit report is a “snapshot” of you and your credit history. The report includes personal information, employment information, credit information, information about judgments and collections, as well as a list of companies that have requested a credit report. Your credit score is a number from 300 to 900, which the lender uses to determine your risk factor. Of course, the higher the score, the better risk you are.
How do they determine these scores?
Credit bureaus use five factors. The first factor, and the most important one, is how you pay your debts. Every time you make a payment or miss a payment, the credit bureau records that information on your credit report file. The two credit bureaus, Equifax and TransUnion receive information every month from creditors and scores fluctuate up or down depending on that information. Payment history makes up 35 per cent of your credit score – that’s the biggest chunk. Had some financial issues in the past? Don’t sweat it too much — the older the information gets, the less it will impact your score. Time heals all!
Count your debt
The second factor is how much you owe – this is where it can get tricky. Lenders will look at how much is already outstanding to see if you can manage more debt. If your credit cards are maxxed, even though you make your monthly payments, it will have a negative impact. How much you owe accounts for 30 per cent of the credit score – another big chunk. Lenders get antsy if your entire current debt load is higher than 35 per cent. So, if you have a credit card with a limit of $1,000 for example, try to use only $350 of it. I know, that’s not realistic, so here’s how to get around that. Never close an account. For example, if you have two credit cards with limits of $1000 each and one is paid off, don’t close it. The global limit is now $2,000, even though one card isn’t used, and you can access $700 without impacting your score.
Experience is always a good thing
Fifteen per cent of your credit score is based on the length of credit history. Basically, this means the longer you’ve had credit, the better the picture a lender has of how you manage your debt. So, if you’re new to credit, your score may be high but your overall report will be weak. Lenders like to see two years of activity.
Don’t ask for too much
The fourth factor, which accounts for ten per cent of the score, is how much new credit you’re applying for. Of course, if you’re just starting out to build your credit, there will be new applications. Lenders are looking for “credit shoppers,” – those who frequently apply for new credit, which could signal financial troubles.
Finally, the fifth factor, which also accounts for ten per cent of the score, is the quality of the various types of credit used. This really doesn’t have much impact unless there’s not a lot of history. For example, if you have a deferred payment plan, it might mean you can’t save enough to purchase the item at the time. Or a consolidation loan means you couldn’t manage your money.
So let’s go back to the original scenario. Once we delve into the details of the credit reports of the couple, the spouse with all the credit is maxxed and is only paying the minimums. If something should happen, like a layoff, then there might be financial hardship. The other spouse, however, while having missed a few payments in that past two years, has had enough pass that those derogatory items are minor. And credit used is well below the global limit. The result, the spouse with the missed payments has the higher score.
While having a high credit score is ideal for getting loans, lines of credits, credit cards etc. no one has a perfect score. Score in the high 600s will get you the best interest rates but scores in the high 500s will still get you credit with some companies. And every six years, credit history changes. So, if you’ve had some financial issues, learn better money management skills and just wait it out until the negative points in your credit history drop off your record.