Social Security numbers, driver’s license numbers, bank account numbers and credit scores – these are just a few of the ways we are identified before anyone even knows our names!
The first three have been around for a long time and we are all aware of their importance, but what about credit scores? What are they, and what do they tell about us?
Recently, the results of the second annual Consumer Federation of America-VantageScore Solutions survey was released which measured consumer awareness of credit scores. The findings showed that consumer knowledge about credit scores has improved over last year, including that 78 percent of survey respondents were aware that they have more than one credit score. Maybe we can thank the media blitz with companies advertising their monitoring services. Whatever the reason, overall, the average score for correct answers increased three percentage points over last year’s survey. Now that more people are aware that they have more than one score, it is important to emphasize what factors contribute to the score – how to make it better, what makes it worse and how it should be interpreted.
Knowledge is power, right? Whether you are a consumer, an employer or a landlord, there are some key misconceptions that are vital to correct for example:
Fewer than half (44%) understand that a credit score typically measures risk of not repaying loans. Let’s say that a little differently: the purpose of a score is to try to predict the likelihood that a person is going to default on a debt. This is important because 22% of those surveyed thought that the score measured the amount of debt. While the score algorithms do take the amount of debt into account, having a lot of credit debt that you make regular, timely payments on may not hurt you as much as having only one or two very low balance accounts that have had late payments.
Another big misconception – over half of those respondents- believed that a person’s age (56%) and marital status (54%) are factors used to calculate credit scores. While the length of time a person has actually had credit is part of the analytics, age and marital status are not. A teenager just starting off on his own may have a lower score because the data does not yet exist to help support him as being a “good risk”. This does not mean that all teenagers are bad and irresponsible, but they have to prove themselves. A middle aged woman who does not have a credit history would have the same problem. A history of making timely payments is what matters, not the age of the consumer. Many people try to help their kids out by adding them as “authorized users” on credit cards to create a credit history. This is a good, legal and helpful practice – if the payments are made on time. Late payments will affect them just as much as timely payments!
Over 20% of those who answered the survey thought that ethnic origin was a factor in determining the credit score. No Way! Not only would this be completely and totally illegal based on Title VII anti-discrimination laws, but there is no part of a credit report that states the origin of the consumer. Even arguing that a person’s name indicates their origin is flawed: people adopt, marry and simply change names every day. Race and color, national origin, sex, religion, marital status, age and sexual orientation play no part in determining a credit score.
So, how do you build your score? Each of the different scores has its own formula for generating the magic number. Essentially, get a few cards and use them, but make the payments on time! You need to have credit, you need to use credit, and you need to pay on time. One thirty day late payment can negate six months of timely payments in regards to the effect on the score.
Inquiries do count against you, but not to the degree that a lot of people tend to think. Avoid stopping at every booth who offers you a free umbrella to fill out a credit application. Not only is this a security risk with too many people having your private information, it will lower your score unnecessarily. You can get an umbrella at any dollar store! The theory behind inquiries lowering your score is that if you were granted credit at every booth you stopped at, the risk of not being able to keep up with all of those new payments increases. That makes sense, right?
While sometimes your credit does need to be run, and it may lower your score, don’t panic. The result is only a few points. There are also some ways to avoid being “double dinged”: if you are shopping for a large ticket item like a home loan or a new car, it makes good sense to shop around. Every company or dealer you speak with will want to run your credit. Most of the different scoring formulas no longer count multiple “hits” from the same kind of business (KOB) within a seven to as much as thirty day time period – depending on the scoring model. This means that if you spend a weekend car shopping, you will only be “dinged” once. Some of the formulas do not even count inquiries that are less than thirty days old.
Another way to possibly reduce the number of times your credit is run is to run it yourself. “Consumer initiated” reports do not affect your score. Run it through www.annualcreditreports.com and take it with you. Although a car dealer may not be able to make you an official offer without running it himself, he should at least be able to give you a quote that you can compare with the dealer you received a quote from just last month.
A less than optimal score does not necessarily mean you have a “bad” applicant. As we have seen, lack of credit history or a late payment or two can drastically affect the score. A credit score should be part of your analysis of your applicant, not the whole.
Credit scores are a helpful tool, but like any other tool, it needs to be properly maintained and used correctly. Learn how to maintain and use, and you will, by nature of the tool, build!
Quantum Scimus Summus (We Are What We Know)