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Credit scores rule the roost
Numbers affect almost every aspect of our daily lives from mortgages to auto loans.
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Do you know what your credit score is?
Relatively few consumers have taken the time to find out, even though their score affects almost every financial move they make. Lenders use the scores in deciding what interest rates to charge for credit cards, auto loans, and home mortgages. Insurers use customized credit scores in deciding who to insure and how much to charge them. Even some employers draw on the same data in making hiring decisions.
"It really does touch your life every day," said Tom Quinn, vice president of global scoring solutions for Fair Isaac Corp., the Minneapolis company that developed the grade-point average of credit worthiness. "In today's economy, your credit rating drives so much of your ability to survive."
Paul from Franklin, Mass., who asked not to be identified to protect his business, said he didn't even know what a credit score was until recently, but now it practically rules his life. When his company encountered financial difficulties, he was unable to pay his mortgage and other bills on time. He needs an infusion of capital to get back on track, but with a credit score hovering around 500, no bank will loan him money and no credit card company will give him a card, although many still send him preapproved solicitations in the mail.
"I've learned the hard way," Paul said. "Fair Isaac and me, we're pretty close now."
A survey released jointly last week by Providian Financial Corp. and the Consumer Federation of America indicated Paul is not alone.
The national poll found that consumers are becoming more knowledgeable about credit scores and how they work, but they have a long way to go. Only 31 percent of those surveyed had obtained their credit score in the last year. Only 27 percent understood that credit scores measure credit risk, not knowledge. Nearly half of the respondents were unaware that a maxed-out credit card would lower a credit score.
Credit scores are three-digit numbers that range from a low of 300 to a high of 850. The higher the number the more favorably lenders view you as a credit risk. The median credit score is 723.
Scores are based on data contained in an individual's credit report. Most individuals have three credit reports -- one from each of the three major credit bureaus, Equifax, Experian and TransUnion -- so most have three credit scores.
Credit reports, which do not include scores, can be obtained for free once a year through annualcreditreport.com, but consumers have to purchase their credit scores.
It's a big business. Fair Isaac, which sells all three scores for $44.85 at myFICO.com, generated $32 million in consumer sales last year. The three credit bureaus charge about $14 for their individual scores. Some financial institutions also offer credit scores to their customers for free.
The three scores are generally pretty close, but not always. My three scores, for example, were all above average, but there was an 89-point spread between the highest (Experian) and the lowest (TransUnion). The TransUnion report seized on two late payments from 1999 that the other two bureaus didn't have.
The reports cite the positive and negative factors affecting your score, but sometimes the reasoning doesn't make much sense. My Experian credit score report said the amount owed on my credit cards was too high, even though I pay my credit card balances off each month. My TransUnion report, by contrast, lauded me for keeping my balances low as a percentage of my overall credit availability.
Most people have a fairly good sense of their credit situation, so there's no need to obsess about a credit score. But knowing your score and taking steps to improve it can pay dividends.
Higher scores generally translate into better credit card offers and lower rates. Providian estimates that a person with a 700 credit score could save $79 a year in finance charges by increasing his score 30 points. The Providian estimate assumes a credit card balance of $4,200 and an interest rate of 11.4 percent.
Much bigger savings are possible on mortgages. Someone with a 620 credit score would be charged about $1,000 a month for a $150,000, 30-year mortgage. By raising the credit score 100 points to 720, that same individual would pay $866, a difference of $134 a month, or $1,608 a year. The higher credit score would also yield fewer or no points and a smaller down payment.
Fair Isaac and ChoicePoint of Alpharetta, Ga., also use credit report data to develop insurance scores. Instead of predicting the likelihood of repaying a debt, an insurance score seeks to predict the likelihood of filing an insurance claim in the next 12 months.
Insurers across the country use the scores to set rates and decide whom to cover, but in Massachusetts and a handful of other states use is more restricted. In 2003, Insurance Commissioner Julianne M. Bowler withdrew a proposal that would have allowed insurers to use credit scores in setting homeowners rates after opponents suggested the scores discriminated against the poor and minorities. Scores play no role in auto rates, set by the state.
But Massachusetts home insurers do use the scores in deciding who to insure (Commerce Insurance of Webster won't insure someone unless their score exceeds a threshold) and where to insure them. Some companies assign customers to subsidiaries with different rate structures based on their credit score.
There are lots of so-called experts out there trying to sell tips on how to raise credit scores, but it boils down to common sense.
"Follow the rules," said Jeffrey Skelton, vice president for insurance services at ChoicePoint. "Pay your financial obligations as agreed on time."
Scores are also influenced by credit utilization. The Consumer Federation of America recommends using no more than 50 percent of your available credit. How long your credit has been established, how aggressively you're pursuing new credit, and whether your credit is concentrated or dispersed also affect scores. No-nos include maxing out on a card, exceeding a card's credit limit, and paying less than the minimum.
Consumers can calculate the impact of missing a loan payment or reducing card balances on Providian's credit score simulator ( www.providian.com).
"There is no quick fix," said Fair Isaac's Quinn. "It's kind of like losing weight. The most effective way to lose weight is when you have a well-designed regimen of food and exercise that drops pounds over time."
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The Detroit News.
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