Everyone, including parents and nannies, has a credit score. Our overall financial health is reflected in our credit score, but what does is track? How do you find out your rating and how is it determined? What impacts your score?
Credit scores reflect your responsibility as a borrower and they are calculated using unique algorithms called scoring models. The scoring models review date provided by three credit reporting agencies – Experian, TransUnion or Equifax. Think of the scoring model as a grade. The better your credit history, the higher your grade.
There are two main types of scores – FICO and VantageScore. The FICO score is used in 90% of all lending decisions and has been around since 1956. It takes up to 6 months of data to create a FICO score. VantageScore was created by the three credit reporting agencies in 2006 as an alternative to FICO to better address changes in behavioral trends and advances in data collection. It only takes one month of credit history to generate a VantageScore.
The three credit reporting agencies collect and evaluate information about installment loans and revolving credit accounts from lenders. Installment credit is generally when you borrow a fixed amount and agree to a monthly repayment schedule – like a home mortgage or car loan. Revolving credit means you have a credit limit and must make at least minimum monthly payments – like a credit card or home equity loan. The diversity of your credit accounts is a common factor in credit score calculation. Having a less diverse portfolio may not decrease our score, but a mix and on-time payments may help raise your score. Monthly bills – such as utility and cell phone bills – are not usually included; however, Experian has a ‘Boost” option that may let you add them to rise your score. If you want to improve your credit score and have paid your utilities on time, Boost is a great option.
So, what is generally included in the credit score calculation? Each credit agency’s algorithm is considered proprietary data and not available to the public. While the exact criteria used by each model are not known, there are 5 known main factors that impact your score. They are known, but not how they are weighted for each agency.
Top Five Credit Factors
- Credit History Length. The agencies will collect data on how long you have been using credit. A more established credit history gives them more data, but if you are new to borrowing, you may have a limited history.
- Payment History. Each agency will collect this data and identify chronic late or missed payments. This is probably one of the most important factors. Chronic late or missed payments will definitely lower your score. Defaulting on accounts resulting in foreclosure bankruptcy, repossession, etc. will negatively impact your score.
- Credit Utilization. This measures how you use the credit available to you. If you have a large amount of credit available to you, and you only use part of it, your score will be higher. To get a high score, avoid maxing out your credit. It’s recommended you only use 30 to 50% of your available credit.
- Credit Mix. Your credit diversity, the types of credit you have is a factor. Is the credit an installment loan or revolving credit and have you made steady payments?
- New Credit Accounts: Any recently opened accounts are considered, especially if there are several opened in a short period of time.
Building a Credit History
If you are new to borrowing, there are ways you can start to build your credit history and grow your score. First, start small. Don’t open a lot of accounts all at once and keep the limits low at about $500-$1000 so you don’t over-borrow. Use the credit card sparingly and pay off the balance each month.
After creating a history of paying this account on time, you can begin to expand by requesting an increase in the credit limit or applying for another credit card or loan. You can also use a secured credit card. This type of card requires you to make a security deposit (usually equal to the credit limit) to open the account. This reduces the risk to the lender while helping you build your credit history. If you are planning to buy a car or other purchase requiring a loan, make sure you save for a down payment. This increases your chances of being approved for the loan.
Bad, Poor, Fair, Good and Very Good
Credit scores are computed and then classified as Bad, Poor, Fair, Good, and Very Good or Excellent. The ranges for these classifications vary slightly among the agencies and may overlap.
- A credit score of less than 300 is generally considered Bad and a high risk to lenders. If your score is in this range, you may be denied credit.
- Poor credit is the rating given to those with credit scores between about 300 and 580. Borrowers with this rating may find themselves at a disadvantage and be required to pay higher interest rates or higher fees.
- A score between 550 and 670 is considered Fair. These borrowers are considered ‘less risky’ and are likely to be approved for credit.
- Good credit scores are in the range of 670 to 739. Lenders are comfortable with this range and likely to extend credit and borrowers may receive lower interest rates.
- Scores above 740 are considered Very Good or Excellent. These scores generally result in easy credit approvals at the best (lowest) interest rates.
There are several ways you can find out your credit score. Many financial institutions (banks, credit unions, etc.) provide your credit score on their online platforms. The credit agencies will also provide your score. You can get on free credit report each year from each agency at AnnualCreditReport.com. Your credit score will fluctuate any time there are changes in your credit history.
How to Improve Your Credit Score
If you are not happy with your credit score, there are numerous ways to improve it, but it takes time and effort. First, you need to determine what may be negatively impacting your score. Having little or no history, late payments, filing bankruptcy or other negative notations are usually obvious. Sometimes older accounts may ‘fall off’ the history is there is no activity for a long stretch of time. There also may be mistakes in your report. If this is the case, make sure you dispute the inaccurate information on your report as soon as possible. Periodically monitor your credit reports to make sure no inaccurate information appears.
Once you have identified the underlying cause(s) you can begin to address them. Building a history should be done in small steps and will take time. Make sure to always submit payments in a timely manner – avoiding penalty charges for late payments. Automatic payments are a great way to build consistency, but make sure the account always has the balance available to cover the payment. Keep a low balance – only use a small portion of your available credit. If you are using a lot of your credit and have the means, make payments twice a month to reduce the outstanding balance owed. If you have accounts with past due balances, make payments to get them current as soon as possible. Limit how often you apply for new credit. Opening several new accounts in a short period of time is seen as risky. Also, the new accounts will lower the average age of your accounts and that may also lower your score.
How long it takes to rebuild your credit will depend on what caused the low score and the steps you take to fix it. The impact of negative events diminishes over time if they are addressed. A lowering after a single missed payment may be a relatively quick fix if you consistently make on-time payments. However, missing multiple payments or falling behind in payments may impact your score for a longer period.
There are companies the advertise that they can repair your credit rating and improve your score. – for a price. This may seem like the ‘easy way out” but they can’t do anything you can do on your own – and at no cost. Also, beware of debt settlement companies. Settling a debt for less than the outstanding balance negatively impacts your credit score.
Your credit score can have a major impact on your financial situation. Once you understand the basics, it is not difficult to take steps that can improve your score and overall financial picture. The US Nanny Institute wants nannies to be informed on important topics like financial management. This is why we include a course to help nannies learn about credit, different types of loans and retirement investments in our Professional Nanny Certification Program.