For today’s borrowers, having good credit is essential.   Having a poor credit history can make it difficult to get loans with good rates, or any loan at all.  People with good and excellent credit are in the best position now to take advantage of the current low rates and reduce their monthly payments.  This is a brief overview of credit scores and what they mean to you.

The most widely used credit scores are “FICO Scores,” which are named after the company that runs the predominant scoring system, the Fair Isaac Corporation.    They have a site for consumers called myFICO.com which offers a Free FICO Score Estimator.  They also offer a number of paid products including Score Watch® and FICO® Quarterly Monitoring.  Other credit reporting and scoring services can be found in our MoneyCafe.com Credit Reports Section.

FICO scores range from 300 to 850.  Higher scores are better, with the average score being around 720.  They keep it a secret exactly how they come up with your score, but say they take into account your payment history, amounts owed, length of credit history, new credit and the types of credit used.  For more detailed information there are two excellent brochures at http://www.myfico.com/Downloads/Files/myFICO_UYFS_Booklet.pdf and http://www.myfico.com/Downloads/Files/myFICO_YCS_Booklet.pdf.

It’s a good idea to know your credit score before you shop for a loan or other credit.  You would be surprised by the difference a good score can make.  On home loans it can translate into savings of a couple of hundred dollars per month or thousands of dollars in additional loan origination fees.   And many people only miss an excellent credit score by a few points.  Check with several lenders to see what scores they use for cutoffs.  Many provide their best rates to borrowers with scores above 740.  Others use 730 or 720 as a baseline to be considered an excellent credit risk.

If you have a low score you may be able to get your score up by making a few adjustments to your credit practices.  A number of things can negatively impact your score – having a maxed out credit card (even if you pay on time), closing old credit accounts and opening new credit accounts.  Often times erroneous information on credit reports is a culprit. 

For an example, let’s say two twins (Jack & Jill) live next door to each other and have identical financial lives.  They have the same jobs, the same amount of credit card debt, and the same amount on their home loans.  They both have the same payment histories.  Jack decides to be smart and take action to simplify his life.  He consolidates all of his credit card debt on to one card which takes up his entire credit limit.  Now he only has one payment.  He closes all of his old credit card accounts and credit lines that he doesn’t need.  While doing some house renovations he opens up store credit cards at Home Depot and Ikea to take advantage of 10% discount offers.  Jill decides to be lazy with this stuff and doesn’t do anything.  She keeps her credit card debt spread out over several cards and is not close to her credit limits.  She leaves open all of her old credit cards and credit lines.  She uses coupons to get discounts and doesn’t open new store cards, but puts the purchases on an unused credit card.  A couple of months later they both go to refinance and discover that Jack’s credit score is lower than Jill’s.  In reality they are the same credit risk; but the credit scoring system will see it differently.  What if, in addition to Jack’s recent changes, he had an erroneous entry in his credit report that was derogatory?  Jack will wind up paying much more for his refinance loan.  The moral of the story – it’s important to pay attention to your credit score and know what’s in your credit report.

You may also want to check out our previous item regarding Free Credit Reports.