Why It’s Important

Good credit is necessary if you plan to use credit to make a major purchase, such as a car or a home, or want to be able to take advantage of the convenience credit can provide. The importance of good credit also extends beyond purchases, in that it may be used by potential employers and landlords as part of the selection process.  Experian (one of the three national credit reporting companies)

Most people understand that good credit is important but often they do not know how lenders determine their credit rating or how to protect their credit. This article is the first of two addressing these two important issues:

  1. How is your credit rating determined and how can you secure a good credit rating? (this article)

  2. How can you protect your credit and your identity from mistakes, fraudulent use and theft? (click here to view)

How is Your Credit Rating Determined?

The Federal Trade Commission (FTC) offers a free 12 page document How Credit Scores Affect the Price of Credit and Insurance that explains the credit reporting and scoring process, and how you can maintain a good rating. That will give you a good understanding of credit reporting and the key factors that go into the process.

Here are some of the important points from the document:

What is credit scoring?
Credit scoring is a system creditors use to help determine whether to give you credit. It also may be used to help decide the terms you are offered or the rate you will pay for the loan.

Information about you and your credit experiences, like your bill-paying history, the number and type of accounts you have, whether you pay your bills by the date they’re due, collection actions, outstanding debt, and the age of your accounts, is collected from your credit report. Using a statistical program, creditors compare this information to the loan repayment history of consumers with similar profiles. Using a statistical program, creditors compare this information to the loan repayment history of consumers with similar profiles. For example, a credit scoring system awards points for each factor that helps predict who is most likely to repay a debt. A total number of points — a credit score — helps predict how creditworthy you are: how likely it is that you will repay a loan and make the payments when they’re due.

Some insurance companies also use credit report information, along with other factors, to help predict your likelihood of filing an insurance claim and the amount of the claim.

Credit scores and credit reports
Your credit report is a key part of many credit scoring systems. That’s why it is critical to make sure your credit report is accurate. Federal law gives you the right to get a free copy of your credit reports from each of the three national credit reporting companies once every 12 months. The Fair Credit Reporting Act (FCRA) also gives you the right to get your credit score from the national credit reporting companies. They are allowed to charge a reasonable fee for the score. When you buy your score, you often get information on how you can improve it.

To order your free annual credit report from one or all of the national credit reporting companies, and to purchase your credit score, visit http://www.annualcreditreport.com, call toll-free 877-322-8228, or complete the Annual Credit Report Request Form and mail it to:

Annual Credit Report Request Service
P. O. Box 105281
Atlanta, GA 30348-5281
For more information, see Free Credit Reports at consumer.ftc.gov.

What can you do to improve your score?
Credit scoring systems are complex and vary among creditors or insurance companies and for different types of credit or insurance. If one factor changes, your score may change — but improvement generally depends on how that factor relates to others the system considers. Only the business using the system knows what might improve your score under the particular model they use to evaluate your application.
Nevertheless, scoring models usually consider the following types of information in your credit report to help compute your credit score:

  • Have you paid your bills on time?
  • Are you maxed out?
  • How long have you had credit?
  • Have you applied for new credit lately?
  • How many credit accounts do you have and what kinds of accounts are they?

Scoring models may be based on more than the information in your credit report. When you are applying for a mortgage loan, for example, the system may consider the amount of your down payment, your total debt, and your income, among other things.

Be Smart – Be Pro-Active about your credit:
Do three things:

  1. Download and read the FTC document How Credit Scores Affect the Price of Credit and Insurance. It’s only 12 pages!
  2. Obtain a free credit report: http://www.annualcreditreport.com
  3. Continue to monitor your credit and regularly obtain free credit reports.

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