Understanding Your FICO Credit Score

Your FICO Score

Your credit score is the largest factor in getting credit. Your credit score is crucial to secure low interest rates on a home mortgage, a car loan, or even the cost of auto insurance. It is a proprietary number assigned by various credit agencies, the largest of which is Fair Isaac & Company (FICO). Five factors are used to determine your credit score in the available range from 300 to 850. Since several companies provide credit scores, the actual number assigned to a person will vary from company to company. While the companies jealously guard their exact formula used to determine scores as secret, the following information has been gleaned from various sources.

 

5 Factors of FICO Credit Score

1) Previous Credit History (35%) – Your previous payment history is the largest determining factor of your credit score. Making all payments on time increases your score. Charge off accounts and slow payments are two things that will reduce your score. Unpaid debts will continue to appear each month as unpaid.

 

2) High Levels of Debt to Income (30%) -The lower the ratio of debt to income, the higher your score will be, as it means that you have more money left over after paying debts, such as car payments, mortgages, and credit card payments. The higher portion of your income that goes straight to debt payment, the lower score you will receive from this factor. Typically, after filing for bankruptcy, your debt to income ratio is improved since you no longer owe the discharged debts.

 

3) Length of Credit History (15%) – A limited credit history may reduce your score up to 150 points. Newer credit holds less weight when determining your credit score on this metric. Older debts with history that were canceled may also hurt your score.

 

4) New Credit Applications (10%) – Every time you apply to get new credit, it reduces your credit score. Credit should only be applied for if it is absolutely necessary and if you know beforehand that you will receive the credit, but changes in the scoring system now allow multiple credit applications without penalty when seeking credit for major purchases such as a home or vehicle.

 

5) Limited Types of Credit (10%) – You should have multiple types of credit, such as a car loan, a home mortgage, and a credit card with a history of on time payments. Having only one type of credit will reduce your score.

 

3 Categories of Credit Score

The three categories of credit scores are prime, sub-prime, and damaged credit score. Prime, the highest tier, is in the 600-650 range. Those with this score typically have no issue getting a mortgage, securing a car loan, or applying for credit cards. A step down from a prime credit score is a sub-prime credit score. A sub-prime credit score is in the 500-600 range. Those with scores in the sub-prime range will see higher interest rates than those with a prime credit score.

 

What you really want to avoid is a score below 500, this is known as a damaged credit score. It is very difficult to get a credit card with a damaged credit score. The credit cards that are available with a damaged credit score typically have high fees and low credit limits. Additionally, some lenders of these types of credit do not report good activity, therefore making it impossible to improve your credit score with on time payments. Insurance is more expensive and you may see interest rates that are twice as much as compared to someone with a prime credit score. For instance, you may pay as much as $8,500 more in interest payments on a $20,000 5-year car loan.

 

Repairing your Credit Score

There are various ways to improve your credit score without filing for bankruptcy. One way is to make your payments on time. Good recent activity will eventually trump previous activity with missed payments. Another way is to keep a low debt to income ratio. Accept increases in credit limit when offered, as the same balance will be a lower debt-to-credit ratio with a higher credit limit. This essentially means keeping your balances low on credit cards and other debts. A third way to repair your credit score is to only apply for credit if necessary. You should be sure you will receive the credit before you apply. The final, but still important tool to repair your credit score is to make sure the information on your credit score is correct. Removing untrue items can improve you credit score. There are forms you can fill out to remove untrue items. Other negative items can also be removed even if they are true because some lenders do not update, supply, or defend information on credit reports. It is also possible to dispute debts on your credit report. This may not eliminate the debt, but it could reduce it. You are entitled to one credit report per year from each of the big three agencies, you can find your credit score on www.annualcreditreport.com.  While the credit report is free, you may purchase a credit score estimate for $7.50.

 

Getting Credit After a Bankruptcy

Looking at the factors relied upon in credit scoring, it is obvious that filing for a Chapter 7 bankruptcy can, over time, improve your credit score. Eliminating most debts, it lowers your debt-to-income ratio. Once the Bankruptcy is filed, creditors may NOT continue to report the debt each month as unpaid; it is reported only once as “included in bankruptcy”. Filing a Chapter 7 Bankruptcy generally increases your ability to repay existing debts. Bankruptcy can improve your chances of getting credit in the future if you consistently make the required payments on time. It is much better to have a clean slate because you filed a bankruptcy in the past than having creditors that you still owe. While bankruptcies dissipate from your record after 10 years, the effect on scoring diminishes after two years, which is generally agreed as the time during which it will be very difficult to get a vehicle loan or mortgage.

 

Credit repair is the process of improving your credit score, but it is not the same thing as credit counseling. Repairing your credit score is crucial to secure low interest rates on a home mortgage, a car loan, or even auto insurance. It is recommended to check your FICO credit score annually. Your credit score can be found for free online from various websites, such as www.annualcreditreport.com.

 

Conclusion

Bankruptcy is a tool to get a new budget and a fresh start. It should be considered if your debts can never be paid with your current income. Just because you have filed for bankruptcy does not mean you will not be able to receive credit in the future. People have been able to apply for mortgages and buy homes within a few years after filing for bankruptcy.

 

Bankruptcy does not stick with you forever, it should be off your credit report 10 years after filing. However, if you were to not file for bankruptcy, “bad credit”, “slow pay”, “no pay”, and repossession can stay on your record until seven years after the final collection activity and then another 20 years from a judgment. It takes approximately two years of timely payments to eliminate the negative effects of a bankruptcy.