Effects of a Bad Credit Score

Buying and selling goods and services is the hallmark of today’s society. Except for the air you breathe, everything you need for living must be purchased - clothes, food, transportation, and shelter. Three little digits known as your credit score have a great influence on your ability to purchase these things.

Your credit score is a numerical summary of your financial history. The number is calculated via an algorithm that takes into account your payment history, debt level, length of credit history, credit applications, and types of credit. Certain actions, such as making several applications for credit in a short period of time, have a negative effect on your credit score, which can range from 300 to 850. The lower your credit score, the harder it will be for you to obtain certain services.

You might first think that your credit score shouldn’t come into play as long as you aren’t purchasing something using credit. Many service providers define credit in a much broader sense. The electricity company defines credit as extending one month of service to you when you. Your cell phone company considers your one- or two-year contract as a form of credit. Each of these companies will use your credit score as a determining factor to extend these services to you.

A low credit score might mean that you pay an additional deposit for services such as utilities and cellular phone service. Even worse, you could be denied for some services solely on the basis of your credit score, even if you have the money to pay for the service up front. Many landlords use your credit history as a basis of extending a lease to you. Some of these landlords establish a minimum credit score requirement. Fall below this credit score and you could be denied the rental, even if you were going to pay for the entire lease up front.

Certain employers use the credit score as a contingency for employment. An application for employment can be denied if your credit score is low.

The same way that a low credit score can seemingly slam doors in your face, a high score can open doors you might not have realized existed. Most people who have high credit scores don’t realize the benefits extended to them. A higher credit score allows you to qualify for platinum credit cards that provide many rewards for credit card use. Lower interest rates and security deposits are some other advantages that a high credit score can yield.

When Credit is Needed

It’s not a good idea to attempt to make a large credit purchase without knowing what’s on your credit report.  When you make an application for most types of credit, the creditor will review your credit report to make a decision about extending credit to you. The last thing you want is to be speechless when a creditor or lenders asks about something on your credit report. Before you make certain applications, you should check your credit report and attempt to reconcile any questionable items on the report.

You should get a copy of your credit report from each of the three credit bureaus before you do any of these things:

1. Purchase a car
2. Apply or get pre-approved for a mortgage
3. Complete an application for rental lease
4. Apply for a student loan from a private lender
5. Take out any other kind of installment loan

Lenders take a deeper look at your credit history when you make any of these applications. They want to be sure that you do not pose a significant financial risk to them in the event that they extend credit to you.

What exactly makes a borrower look like a financial risk? One of the first things that will get you turned down for any of the items listed above is a charged-off account within the past two years. It’s worse if the charge-off hasn’t yet been paid. In most cases, you will not be approved for a loan or credit with a charge-off on your credit report.

Unpaid collections are another blemish that lenders view as unfavorable. While unpaid collections aren’t as bad as unpaid charge-offs they can still cause you to be denied for an application. If the collection is inaccurate, you have the right to have it removed from your credit report. To keep from having to give an explanation to the lender, you should have the inaccuracy removed before making your application.

A history of late payments and high balances on accounts are also habits that cause lenders to deem you as a credit risk. Review your credit report to see if either of these items applies to you. If so, get caught up on your payments and bring down your balances to increase the chances of getting your application approved.

Even if you feel fairly certain that your credit report only contains positive information, it is still a good idea to get a copy before making applications in these situations.

New Credit Mistakes

Credit card companies seldom teach first timers the proper way to use a credit card. Why would they? They make more money from people who don’t know exactly how to be responsible with a credit card.

In all the excitement of receiving your first credit card, there are some common mistakes that you can avoid to ensure your credit remains favorable.

One of the most common mistakes that beginners make with credit cards is charging more than they can afford. At first, a credit card seems magical. You can purchase almost whatever you wish, without having to spend any of your money. This mentality is why many beginners max out their credit card within only a few months of receiving it. The best rule of thumb is to charge only what you can afford to pay. It may sound contradictory to the theory of a credit card, but it is the best way to keep your head above debt waters.

Another credit mistake that beginners often make is getting too many credit cards during a period of time. With all the pre-approved offers in the mail and store clerks asking you to get their credit card, it can be tempting to open several credit cards at one time. Many beginners think the more credit cards they have, the more they will be able to spend. While this is true, there is another side to that coin. The more you spend, the more you will have to pay. Chances are if you have several cards with balances, you will run into some difficulty making the payments. One or two credit cards are sufficient for someone just starting their credit history.

Paying the minimum payment only gets many beginners into more debt than they expected. When you make only the minimum payment it usually covers the interest and a small amount of the credit card balance. It could take years to pay off a balance as low as $300 when you pay the minimum payment. Although you don’t have to pay the entire credit card balance every month, you should pay a little more than the minimum balance. This is especially true if you are continuing to accrue new charges.

What Makes Up a Credit Score?

There are five main items that make up your credit (FICO) score: payment history, outstanding debts, credit history age, inquiries, and account types.

Each of these items is given a different weight in the algorithm that determines your FICO score. Payment history is 35% of the score, outstanding debt is 30%, credit history age is 15%, and both inquiries and account types are 10% of your total FICO score.

Now you know what components are included in your credit score. What does each of these include? More importantly, what’s considered good and what’s bad for each component?

Payment History

Your payment history includes the details of how you’ve been paying your bills. That is, if you’ve been paying them at all. Each of your credit accounts reports your payments as on time or late. Late payments are reported as being 30-, 60-, 90-, and 120-days late. After six months of non-payment, many creditors charge-off your account, deeming it as an uncollectible account. The more recent the late payments are, the worse the effect it is on your credit score. Timely monthly payments boost your score in this area.

Outstanding Debts

This portion of your FICO score takes into account the total amount you owe on all your credit accounts. This includes credit cards, student loans, auto loans, mortgages, lines of credit, etc. Not only does the FICO score consider the total amount you owe, it also considers the total credit you have available. This ratio is known as your credit utilization. The higher your credit utilization - meaning the closer your balances are to the limit - the lower your credit score. You should keep credit account balances at or below 30% of the limit.

Credit History Age

The length of time that you have had credit is a determining factor of your FICO score. A longer credit history is better than a shorter one. This is because there is more data to create a pattern of good or bad payments.

Inquiries

Each time a business uses your FICO score to make a credit-based decision about you, an inquiry is made to a credit bureau. This inquiry then appears on your credit report. Multiple inquiries within a relatively short period of time have a negative effect on your FICO score, especially if these are credit card inquiries. Few to no inquiries is better. The good news is that only inquiries from the past two years are factored into your FICO score.

Account Types

When you have several different types of credit accounts - loans and revolving credit - it is better than having a single type of credit account.

Getting a Free Credit Report

Many very misleading “free” credit report offers are being advertised right now and are duping customers.  They’re not free at all and are only provided to you once you pay for another service or product.

Getting a credit report at least once a year is ideal for maintaining your financial health. Even if you have a good idea of what might be contained in your credit report it is still a good idea to check it. Why? The financial institutions that report your information to credit bureaus deal with thousands, if not millions of consumers. It is quite possible for mistakes to be made. Balances could be reported incorrectly, paid off accounts might not be updated. A simple slip of the finger could put someone else’s derogatory information on your credit report.

The three credit bureaus - Equifax, Experian, and TransUnion - maintain their data independently. Not only that, some of your creditors and lenders might deal with one credit bureau, while others might deal with another. You should check your credit report with all three credit bureaus.

Through the Fair and Accurate Credit Transactions Act, you have the right to receive a free credit report from each of the three credit bureaus once a year. Although you are given this right, it is still your responsibility to obtain your report. The credit bureaus will not send your report automatically. You can request your free credit report by visiting www.annualcreditreport.com. Regardless of anything else you read on the internet, this is the only site through which you can obtain your free annual credit report. If you prefer to order your credit report by phone you can do so by calling 877-322-8228.

Note that there are other companies that provide free credit reports through their own promotions. Even some of the credit bureaus have promotional deals that allow you to order a credit report for free. Be advised that these promotions do not provide the free credit report granted to you by the Fair and Accurate Credit Transactions Act.

Each of the three credit bureaus gives you the option of ordering your credit report through their websites. In most cases, you can purchase a single credit report for $10 or the three-in-one credit report for $30. Obtaining your credit score comes at an additional cost.

Be careful that you don’t attempt to purchase your credit report through a scam website. You should be wary of any company that promises to fix your credit report or give you excellent credit by cleaning up your credit report. If you don’t trust a company’s website, it’s best not to input your personal information. For the most trustworthy method of obtaining your credit report, use the methods mentioned above.

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