finance

Why Your Credit Score Matters

Whenever you borrow — be it for business or home, lenders scrutinize your credit score.

JOHN PEMBROKE, O.D., M.B.A., F.A.A.O.
Tahlequah, Ok.

Regardless of your mode of optometric practice, an understanding of how to optimize your credit score will benefit your financial well being.

Get to know FICO

Fair Isaac Corporation (FICO) develops software that produces most of the United States and Canada with credit scores. FICO provides a quick look at a person's overall credit status at a particular point in time, affording credit card companies, car dealerships, banks, etc. a reliable guide to future financial risks.

To assess your credit worthiness, lenders request your score via one of the three major credit reporting agencies: Equifax, Experian and TransUnion.

In the eyes of lenders, consumers with high FICO scores (see below) receive lower interest rates from the aforementioned businesses because they pose less risk of missing payments or defaulting on a loan. (In addition to credit worthiness, lenders consider the amount of debt the consumer can handle compared to his income.) A slight score improvement could save you tens of thousands of dollars through the life of a loan.

The recent wave of defaults in the sub-prime mortgage sector has left two million people facing the possibility of foreclosure, according to the Cable News Network (CNN) and the Center for Responsible Lending. This foreclosure crisis may result in your FICO score playing an even greater role in your ability to obtain a desirable loan. How so? A foreclosure decreases your credit score by 200 to 300 points, depending on your overall condition of credit, according to real estate agent Elizabeth Weintraub's report on about.com.

The FICO score ignores age, salary, occupation, location, race, religion, national origin, sex and marital status. The dollar amount of a payment isn't significant in determining your credit score. A critical factor is a long consistent payment history, even if the payments amount to only $10 a month.

Keeping score

FICO scores range from 300 to 850, with higher scores representing better credit worthiness.

Lenders offer the lowest interest rates to borrowers who have a FICO score of 760 or better — a high achiever — as they consider these consumers low-risk for missing a payment or defaulting on a loan.

The FICO score takes into account the number of open credit accounts. On average, a consumer has a total of 13 credit obligations. The FICO high achiever averages six credit accounts paid as agreed, which typically consist of three revolving credit accounts (i.e., credit card, department store card), and three installment accounts (i.e., auto loan, mortgage loan).

Your payment history represents 35% of your FICO score. About 93% of FICO higher achievers haven't missed a payment in seven years. Delinquent payment and collection have a major negative impact on your credit score. In fact, delinquencies may stay in your credit file for seven to 10 years.

The utilization ratio, representing 30% of the FICO score, compares the credit usage to the total available credit. A typical consumer uses less than 30% of their total available credit. For the FICO higher achiever, the ratio averages 7%. The balance of the last credit statement is generally the amount shown on the credit report, even though the higher achiever pays his credit account in full each month.

The oldest credit account, the newest credit account and an average age of all credit accounts represents 15% of your FICO score. For FICO high achievers, the average age of all credit accounts runs from six to 12 years with their oldest open for an average of 19 years.

To attain FICO high achiever status, open new credit accounts only as needed, and avoid closing credit accounts so you can work toward a long credit history with few accounts.

New credit, representing 10% of the FICO score, lowers your score because lenders consider those who actively seek credit a greater risk than those not seeking credit.

The types of credit you use represent 10% of your FICO score. The score considers your mix of credit cards, retail accounts, installment loans and mortgage loans, but it's not necessary to have one of each.

How to improve your score

There's no fast way to improve your FICO score. However, by using these general tips, you will eventually increase your credit score and improve your credit profile.

► Pay on time, and never miss a payment. As mentioned earlier, delinquency can remain in your credit file for seven to 10 years. More severe delinquencies remain longer.

► Pay early to improve a score.

► Keep revolving credit balances low. The high achiever typically uses less than 10% of the total credit limit.

► Correct inaccurate information in a credit file.

► If derogatory information is on your credit report, write a "Goodwill Letter" explaining the situation, and be specific about the request. Frequently, the lender will forgive and remove derogatory information from a credit file in an attempt to keep you, the customer, satisfied.

► Be careful of closing revolving accounts. Closing an account doesn't automatically remove it from your credit file and the credit score software may still consider it in calculating your credit score. If you don't have a high number of credit accounts, it may be advantageous to keep the existing credit available to influence debt to credit ratio.

► There's no "golden rule" on the number of charge cards you should have, but opening cards to gain a small savings is usually not a good idea.

► Educate yourself about credit and credit scores, and obtain a credit report every six to 12 months to stay on top of your score.

► If you're having trouble making ends meet, notify the creditor to make suitable payment arrangements, and follow a credit counselor's advice. These actions won't improve your FICO score immediately, but your score should improve through time.

► Prior to applying for major credit, request a credit report allowing time to improve your score, if needed. Obtain your FICO score at myFICO.com for approximately $5.95.

Using the first credit card responsibly can help establish credit history, while using it irresponsibly can damage credit history. However, the bottom line for all borrowers is the same: Use credit wisely and cautiously and always pay bills on time. OM

Dr. Pembroke is an assistant professor at the College of Optometry, Northeastern State University, where he teaches practice management. Dr. Pembroke had a private practice in Rock Springs, Wy., for 28 years before joining NSU-OCO in 2005.