The Importance of Knowing Your Credit Score

How to start your debt management strategy? By knowing where you stand, debt-wise. That means knowing what credit report bureaus and lending and credit organizations think of you. Not as a person, per se, but as a credit risk.

One of the best ways to do that is to know your credit score. Credit scores are the answer to the question "How can debt problems be cut off in advance?"

Credit scores are the marks that credit report agencies bestow upon you and share with the rest of the world - or at least with the part of the world that might want to extend a loan to you or green-light good credit for you.

You'd think people would want to know what credit score they've been given and what that score means to their lives. When you think about it, your credit score is a huge factor in your life. It can mean the difference between owning a house or renting one; going to an Ivy League school or a community college; or driving a new Lexus or an old LeBaron.

But people don't seem to care what their credit score is. In fact, it's downright funny how some people can rattle off trivial information at the drop of a hat but have no clue when it comes to knowing their financial status. You want the lowdown on the latest Hollywood scandal? No problem - got it all for you right here. What's that recipe for Bruschetta? Wait - I have it here in my back pocket.

What's my credit score? Ummm. . . what's a credit score? Knowing your credit score and what it can mean to your financial future is a big deal. While knowing the latest Hollywood gossip or having the secret ingredient for that to-die-for party dish may pay off in your social circle, knowing your credit score - and knowing how to improve it - offers significantly greater rewards. Say, a better house or a good college education for your kids.

Why are credit scores important? And what are they? A credit score, also known as FICO scores, are used by creditors to figure out if you're a good credit risk or not. It tells them whether it's a good bet that you'll pay off that student loan or make payments on that new big screen television in a timely fashion.

Creditors make those calculations based on the data included in your credit report. As a U.S. citizen, and presumably the owner of a Social Security number, you're financial history is a public record. In virtually all cases, your financial background can be found, condensed including payment history, at any one of three credit report agencies: Equifax, Experian and TransUnion. Each of these companies are veritable clearinghouses of personal financial information of anybody, citizen or not, with a U.S. Social Security number. The information each provides can make or break some of your biggest financial moves, from owning a home to opening your own business. Credit scoring mechanisms are fairly easy to understand. A credit score in the low 600's signals a problem for a lender. That doesn't mean you can't get a loan, but it likely means you'll pay a higher interest rate to get it. On the other hand, a score in the upper 700's is a joy to behold for a lender - and for you; too, as you'll probably get the loan at a lower rate since you're such a good credit risk.

Credit agencies look at people with similar financial backgrounds and habits to assign your score. That model includes past credit history, any big purchases made (and whether it/they were paid off or not), and job and income estimates. Based on the collective "credit history" of loads of people who are a mirror image of you financially, your credit score is meant to forecast your future ability to handle debt and make timely payments to lenders and creditors. Your credit score is based on five key financial criteria (as follows):

Payment History: About 35% of your credit score is based on your bill payment history.
Amounts Owed: About 30% of your score is based on the amount of money you currently owe.
Length of Credit History: About 15% of your score is based on how long you've been taking on bills - and paying them.
How Much Credit? About 10% of your score is based on new credit activity.
Types of Credit: About 10% of your score is based on the kinds of credit you have, i.e., car payments, mortgage payments, credit card bills, school loans and the like.

Lenders and creditors also prefer to look at public record and collection items - things like bankruptcies, judgments, suits, liens, wage attachments and collection items. These are considered "red flags" by lenders, although older items will count less than recent ones.

They'll also dig a bit deeper and check out details on late or missed payments and public record and collection items - specifically, how late they were, how much was owed, how recently they occurred and how many there are. A 30-day late payment is not as risky as a 90-day late payment, for example. But recent bill-payment activity and frequency count too. A 30-day late payment made just a month ago will count more than a 90-day late payment from five years ago. Note that closing an account on which you had previously missed a payment does not make the late payment disappear from your credit report.

What's not part of your credit score? Things like your income and bank balance, the interest rates you pay on other loans, your occupation, job title, employer, time with your company, and employment history do not count on your credit score.

What Can Hurt Your Score - And What Can Help It