• Online
  Degrees
• Online
  Programs
• Online
  Courses
• Online
  Colleges
• Campus
  Programs
• eLearners
  Advisor
• Articles &
  Resources
• Blogs &
  Forums

Credit, Credit Scores, and You

All About Credit

The concept of credit is as old as civilization. The term itself comes from credo, the Latin word for trust. Ancient Assyrians and Egyptians had systems of credit, not to mention harsh penalties for those who couldn't repay. Modern day credit cards were popularized during the 1950's and 1960's, after The Diner's Club introduced charge cards for traveling professionals who entertained at various restaurants.

These days, credit is more common than cash — with some disconcerting repercussions. Retailers are constantly trying to entice consumers with promises of "no money down," or "easy payment options." Offers for new credit cards inundate our mailboxes and inboxes.

A recent CNNMoney.com report reveals that the average American family carries more than nine thousand dollars in credit card debt. And given the unfortunate prevalence of credit fraud and identity theft, an entire industry has been built around the need to monitor and protect people's credit.

How credit is used today.

Using credit essentially means that you can purchase something without paying for it right away.

In a credit-based transaction, a borrower is promising a lender that he or she will compensate for the item according to a mutually agreed upon set of terms.

The terms usually include a payment schedule (i.e. what portion of the total amount must be paid every month), and a rate of interest — an additional percentage of the total, added on as a fee for the privilege of being granted credit.

What are credit bureaus?

Amidst so much charge traffic, it's easy to get confused. Is anyone keeping track of all the borrowing? The good new or the bad news (depending on your situation) is that the answer is yes.

Credit bureaus — a.k.a. reporting agencies — are agencies that investigate and compile your entire credit history. These bureaus sell the information they collect to creditors — including mortgage lenders and credit card companies — who are trying to decide if and how much credit they will lend to you. In the United States, the three major credit bureaus are Equifax, Experian, and Trans Union.

What is a credit score?

Your credit score is derived from the information in your credit report, which is like a logbook of all your financial footprints. Your credit report includes a history of how reliably you pay your bills, when and how much credit you've applied for, and even how often other people are checking into your report.

This credit report, and the score that's assigned to it, are representative of your overall credit-worthiness (i.e. how well you are able to pay back any debts). In addition to determining your credit-worthiness, your credit score is used to calculate the rate of interest you'll pay on loans or credit card purchases.

If your credit score is on the low side, some lenders might consider you a higher risk — someone more likely to "default on," or not repay what you owe. As such, you may be denied the credit you're applying for, or you may be given a higher interest rate.

How is a credit score determined?

MyFico.com, a division of the Fair Isaac Corp, offers the following breakdown on what data determines your FICO score:

• 35% – Payment History
  Your payment history will include any incidents of late payment or accounts that were handed over to collection agencies. Bankruptcies and liens will adversely affect your score. The number of delinquent accounts you have, and how recently the problems occurred are all factored into this measurement.
• 30% – Amounts Owed
  The overall amount you owe to different lenders is a major consideration, as is the proportion of your debt in terms of your entire credit line, or limit. That means, even if you're allowed to charge up to eight thousand dollars on your credit card, your credit score will be higher if you only owe eight hundred, as opposed to seven thousand. As a rule, financial experts recommend that you try to carry less than twenty-five percent of your limit.
• 15% – Length of Credit History
  Creditors look favorably on people who have longstanding accounts. The history shows you've been responsible enough to manage open credit for a significant period of time.
• 10% – New Credit Inquiries
  Every time you apply for new credit (e.g. a car loan, a new credit card or a mortgage), your report will reflect the inquiry. Having a lot of inquiries can give the appearance that you are borrowing excessively.
• 10% – Different Types of Credit
  Credit scores are improved when they include various types of credit. Having an open credit card account gives you the type of credit that's termed "revolving" credit. It's helpful to supplement revolving credit with credit you pay back in even installments, for a fixed period of time (e.g. a car or student loan).

How do I find out what my score is?

At any given time, there are actually several different versions of your scores and reports. The different versions are used by different types of lenders, and may or may not be available for your personal review.

According to a recent Wall Street Journal article, the most widely used score is the FICO score, developed by the Fair Isaac Corporation. Standard FICO scores range from 300 to 850. Each of the three major credit bureaus assigns you its own FICO score, based on the information it has in your report. Standard FICOs are used by all mortgage lenders when you're being considered for a home loan, and can be obtained via Equifax.com. MyFico.com, or TransUnionCS.com.

Using variations on the standard FICO formula, agencies also produce and distribute Alternative FICO scores. These scores are slightly different than your standard score because certain elements have been weighed more heavily, depending on the type of credit being requested. Credit card companies, auto loan brokers and other installment loan providers receive this type of score when considering your application, but you aren't able to access these numbers.

Besides FICOs, the credit bureaus offer their own versions of scores, like VantageScore and PLUS Score. You can access these by visiting bureau websites, and in some cases, when you request a free credit report. Again, though these results will still be coming from the same pool of available data on your credit history, the numbers will vary because of the different formulas and score ranges being used. Credit bureau scores can be useful in getting a general picture of your standing, but experts recommend that you buy your standard FICO if you are planning any major credit decision.

How can I improve my credit score?

Once you've obtained your credit score, you may be looking to boost it. MyFico.com offers the following suggestions for improving your credit score:

• Pay your bills on time. If you haven't done so in the past, start! The more distance you can put between today and your last monetary misstep, the better it will appear. Over time, regularity will improve your score.
• Be careful when and how you consolidate your debt. While it may be convenient and cost effective to make one, large monthly payment in place of four or five, with varying interest rates, this move might also cost you credit score points if you're closing out longstanding accounts and/or maxing out one line of credit. Get advice from a reputable financial advisor who can help you weigh the risks and gains.
• Don't apply for new credit unless you really need it. Even though some of those fancy department store cards may look pretty in your wallet, you're doing yourself a disservice by collecting them.
• Request a copy of your credit report from each of the three major credit bureaus. Carefully review the information and report any mistakes right away. The bureaus are required to investigate any disputes you claim within 30 days and/or remove the erroneous data.
• Keep your balances as low as possible by not charging unnecessary items like vacations or restaurant dinners. Cash is king!

"Extra" Credit

Credit might sound like a complicated subject, but it's worth your time to be informed. Credit scores determine how high your interest rates will be on your home and car loans. Insurers use scores to base your monthly insurance rates. Credit scores may also be used by landlords and prospective employers, who view your score as a representation of your stability, and therefore, whether or not they feel confident doing business with you. Some cell phone and utility providers request to view your credit report before initiating service. Across the board, a better score can translate into huge savings and fewer headaches. So stay on top of your finances, and get credit where credit is due.

---

Elizabeth Demeo is earning an MFA in Creative Writing. She is a contributing writer at eLearners.com and GradSchools.com.

We welcome all comments directed to: recession [at] elearners [dot] com.