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Recently, I’ve seen an upsurge in basic credit questions sent in by readers. Credit laws change. Credit rating agencies revise their products and their evaluation criteria. When I write new information about a topic I’m prompted to action by the credit industry, which remains in a constant flux state. This can be confusing since we prefer stable money rules.
You may think that learning personal credit feels more like studying a Chinese puzzle box with secret assembly instructions than piecing together a straightforward multicolored jigsaw puzzle. Many people would share that perspective. (For background information defining credit, please see, What Is Credit?) The credit puzzle, as it stands today, is made of these elements:
Equifax, Experian, and TransUnion collect your personal credit usage data to create your credit history. One company, Fair Isaac Co. (FICO), customizes their proprietary software for these three credit reporting agencies (CRAs). Each agency analyzes your credit history with emphasis on different information. That analysis produces your FICO scores, which range between 300 and 850. This is why you have three different FICO scores.
Unfortunately, you can no longer purchase your FICO score directly from Experian or TransUnion. Using different software, they now produce and sell “FAKO” scores, which range between 501 and 990. A person receiving a FAKO score of 800 might think they have no credit concerns. They could be surprised to discover their FICO scores hover in the high 600s, making them incapable of qualifying for the mortgage or automobile loan they expected to secure. Creditors use FICO scores most frequently. Experian and TransUnion continue to provide FICO scores to commercial accounts although they will not sell them to consumers.
You need to know your FICO scores. When you order your free annual credit report from Equifax, also order your FICO score from them. Current price: $7.95. That’s your only direct source to purchase a FICO score. If any merchant, including a mortgage banker, checks your credit, ask for a copy of your whole credit report so you can verify information accuracy. Your three FICO scores will be listed on a mortgage credit report.
Six Key Credit-Building Requirements
- Pay all bills on time. Habitual late payments will destroy your credit.
- Use less than 30 percent of the credit limit on each account, or 10 percent for faster credit score improvements.
- Don’t close old accounts. Your credit history creates approximately one-third of your credit scores. When you close old accounts, you may be gutting a significant chunk of your credit scores.
- Keep high-limit accounts open. Your total available credit computes as part of your credit scores. When you close an account with a high limit, your available credit diminishes and your credit ratings drop. See: How You Can Benefit from the New Credit Card Rules for what to do if your credit card terms change in unacceptable ways.
- Remain vigilant about checking credit reports quarterly to be certain information reported about you is accurate. See: How to Correct Mistakes on Your Credit Report.
- Don’t allow your credit to be checked until you’re ready to make a purchase. Every credit inquiry shaves points off your credit scores. The more frequent the inquiries and the higher the total number of checks during a short timeframe, the greater the credit hit per inquiry. FICO’s analysis software reads many inquiries as a person who desperately needs access to money. I’ve seen numerous inquiries during a couple of months drop excellent credit scores by more than 100 points.
Business Credit Basics
The Dun & Bradstreet (D&B) method of scoring your business payment history, their Paydex Score, is far more straightforward and understandable than personal credit. However, Experian combines your personal credit history with your business credit history to determine your business credit rating. For individuals who have experienced personal financial tragedy, while keeping their personal credit completely separate from their business credit, this seems immensely unfair. If an executive in a larger company is forced to file for bankruptcy because her husband’s long-term illness wipes out their insurance coverage, all their savings, and the executive incurs debts she is unable to pay, that business would not see its credit rating suffer. With the exception of D&B’s Paydex Score, little about credit evaluation is easy to understand. See my series on building business credit to learn how to develop excellent business credit.
Future Credit Management
This fall, a new company will introduce a consumer-friendly product to provide credit transparency and help you manage your credit. While I cannot reveal details yet, you will be able to use this tool to determine how credit options will influence your credit ratings. This is something I would have produced if I could have figured out how to develop the software. When I can describe the usefulness and value to you in detail next month, you’ll want to use it to evaluate the best decisions for your life.