Written by Rick Salmeron
for Realty Times
It is common to assume that paying bills on time automatically means
having a high credit score. Unfortunately, that's not always the case.
There are many misperceptions about how scores are calculated -- and
yours could be lower than you might expect.
Credit scores are
used by financial institutions to determine whether they should lend
money to a potential borrower and, if so, what interest rate should be
charged. A higher score means an applicant is statistically less likely
to default on the loan so they get a lower interest rate.
credit score could be a costly mistake. As an example, let's say you
bought a $400,000 house with a 30-year fixed-rate mortgage at a
6-percent interest rate. Over the term of the loan, you would pay
interest charges of $463,354. If, however, you had a lower score and
your bank bumped your interest rate up to 8 percent, you would pay
interest charges of $656,619. That's a hefty difference of $193,265.
There are many
credit scoring systems available to lenders, but FICO scores are by far
the most commonly used. The system was developed by the Fair Isaac
Corporation back in the 1960s. Technically, you have three different
FICO scores -- one for each of the three major credit reporting
Knowing how FICO
scores are calculated can help you make better decisions about your
credit. At a minimum, you should be aware of some of the most common
I always pay my bills on time so I must have a high credit score.
Paying your bills
on time is clearly a critical factor, but it only accounts for 35
percent of your overall FICO score. It also looks at four other
components: the amount of debt you owe (30 percent), the length of your
credit history (15 percent), the number of credit accounts you've
recently opened (10 percent), and the types of credit you use (10
Consolidating multiple credit cards will increase my score.
credit cards could make it easier to pay down debt, but your FICO score
could actually decrease if you consolidate to fewer accounts with
balances that are closer to the maximum available credit. FICO
considers you a lower risk if you have multiple credit accounts, keep
the payments up-to-date, and maintain balances between 25 percent and
35 percent of the available credit.
I don't have any credit cards or other major debt so I can't have a low score.
Your FICO score
doesn't take into account your net worth or your income level -- it
only looks at your past borrowing history. Your FICO score will be
lower if you haven't established a long-term borrowing history with
Closing a credit card is better for my score than keeping it open.
Closing a credit
card will not necessarily hurt your score in the short term, but you
will eventually lose the positive effects of the long-term credit
history that you've established with that lender.
I shouldn't shop around for a mortgage or other large loan because credit inquiries hurt my score.
A large number of
credit inquiries will lower your score, but FICO is smart enough to
know when you are rate shopping. Inquiries for similar types of credit
are bundled if they're made within the same 14-day period.
I shouldn't check my credit report more than once a year because credit inquiries hurt my score.
Checking your own credit report does not affect your score, so feel free to check it as many times as you'd like.
If you want to
learn more about how FICO scores are calculated, visit Fair Isaac's web
site at www.myfico.com. They offer a host of informational materials
and credit score tips. And while you're at it, you can also order your
three scores for a small fee. Becoming more
knowledgeable about FICO scores could help you to keep those pesky
interest rates at a minimum. With just a small investment of time, you
will be able to make smarter credit decisions and take proactive steps
to increase your score.
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