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Credit Scores 101

By Mandy Marger

Much is made of your “scores” in life. Your school grades partly determine where you go to college and are sometimes considered in employment evaluations. Your health scores (weight, blood pressure, cholesterol, etc.) determine if you are high risk for certain ailments and are also considered by insurance companies when you apply for coverage. These numbers aren’t the best representation of an individual, but for the institution that is interested in that aspect of your life, they are a reliable, concise view of that facet of you. The same can be said for your credit score and the lenders and groups who are interested in your financial history.

Consider financing a house. Lenders with the capital to back your mortgage note need to be convinced that you are a “good student” who is worthy of them blindly trusting you to pay them back. And while a mortgage is a large and obvious instance where your credit score is scrutinized, there are many other reasons it is referenced when an organization is screening you. Knowing this, and considering it takes time to establish and change your score, it’s important to keep tabs on it and think about it when making financial decisions.

Who Uses Your Score?
It seems logical that a company that you are asking to lend you money would check your credit score. This could include credit card companies, mortgage lenders, as well as car and student loan lenders. But you might be surprised to learn that utility companies, insurance companies, cell service providers, and even your employer can use your credit score to make judgments about providing services or hiring you.

A Recipe for Good Credit
The Fair Isaac Corporation (FICO) is one of the largest predictive analytic firms whose scoring models are used by a large portion of lenders. Their basic formula for calculating your score uses the following breakdown:

•35 Percent Payment History – Demonstrating that you are financially responsible by paying your bills on time is the largest portion of your score. Late payments will drastically affect your score, and in the case of mortgages, a past-due mortgage payment can keep you from obtaining a new loan for up to 12 months.
•30 Percent Amounts Owed – Also called credit utilization, this refers to how high your balances are compared to your credit limits.
•15 Percent Length of Credit History – This refers to how long your credit accounts have been open.
•10 Percent Types of Credit Used – This refers to the mix of accounts you have, such as revolving (credit cards, retail stores, personal loans) and installment (fixed-payment loans like mortgages, car, and student loans).
•10 Percent New Credit – This is about your pursuit of new credit, including credit inquiries and the number of recently opened accounts.

Planning Ahead
If you have a future major purchase that you plan to finance, it is a good idea to prepare well in advance. Check your credit annually using an accredited free service like It is estimated that one in five Americans have an error on their report, so review it carefully, and open a dispute (if needed) so problems can be resolved ahead of your application. You will save yourself time and heartache if you fully understand your budget and finance options before you begin shopping for a home or car. Make plans to speak with a mortgage broker or other finance professional several weeks before looking at homes or hitting the road for a test drive.

Maintaining Healthy Credit
As complex as your credit life can be, it’s important to stay mindful about your credit health. Consider your daily credit changes and the potential benefit or detriment of opening a new charge card. Plan to save and pay in full for moderately large purchases, such as jewelry and electronics, so that financing does not affect your credit utilization. Try to keep all bills current and credit utilization under 30 percent. If you are newly establishing or reestablishing your credit history, speak to a finance professional or counselor about the best way to reach your goals.

Your credit score is both a complex and overly simplified representation of you. Just as you need to work to maintain grades and your health, it takes effort to keep your credit score/profile up to par. Though it may seem complicated to build and maintain a good score, your efforts will pay off in financial savings (lower interest rates) and peace of mind.

Credit Score Conceptions — True or False?
Credit inquiries will lower your score. True, but there are exceptions. Generally, when your score is pulled by an interested party, it will take a “hit” of less than five points. However, when shopping for a mortgage, car loan, or student loan, you will not be penalized for having credit pulled by multiple lenders in a typical shopping time frame of about 14 days. Credit inquiries remain on your report for two years, and studies show that those with six or more inquires on a report are up to eight times more likely to declare bankruptcy than people with no inquiries on their reports. With that knowledge, you can understand how an inquiry might affect your score by a more significant amount if you have a greater inquiry history.

The credit report I see on my free report is my actual score. False. There are many different credit score models; each is used for various credit purposes. So, you may have a different score depending on what an organization is trying to glean from the report. The free scores that you can (and should) be reviewing once a year are based on an educational scoring model; whereas the score your mortgage lender sees is based on a lending scoring model. Even when your scores are pulled from more than one credit scoring company, it’s not always your best that is used. For instance, during a mortgage application, your “middle” score will be used – this would be the middle value of a tri-merge score, which is where lenders pull your report from each of the three major companies (Equifax, Experian, and TransUnion). And again, considering mortgages, if you have a co-borrower, it would be the lowest of the mid scores of all borrowers that would be used to tabulate qualification and interest rate.

I can pay to have my credit repaired. False. Indeed, attorneys at the Federal Trade Commission (FTC), the nation’s consumer protection agency, say they’ve never seen a legitimate credit repair operation making bold, boastful, or “guaranteed fix” claims. Instead, they suggest seeking out a certified credit counselor who can help you make the necessary repairs through education and effort.

How Good Is Your Credit?
Having a good or excellent score can make securing financing easier and offer you better interest rates, saving you money in the long run.
Excellent: 750 and above
Good: 700-749
Fair: 650-699
Poor: 550-649
Bad: 549 and below