The Importance of Good Credit

Let's face it - like it or not, the world runs on credit.  Credit is defined as a means of borrowing money from a person or company and returning it at a later date, usually with accrued interest charged on top of the initial sum borrowed. For some, it is mostly the convenience of not carrying around a lot of cash.  For others, who live from paycheck to paycheck, credit is often the only thing that keeps them solvent. Credit cards have become such a way of life that television advertisers scoff at the person using cash or writing a check. The focus of this article will be on the importance of having good credit.

Who determines your credit rating?

The standard for credit rating is determined by the Fair Isaac Corporation (FICO).  FICO uses different criteria to determine a credit score. Although there is a lot of controversy about the actual numbers, using scores from 350 to 850 gives a good overview of credit score. 

Based on the general population, these scores break down like this:

• Payment history: 35%
• Amounts owed: 30%
• Length of credit history: 15%
• New credit: 10%
• Type of credit used: 10%

As you can see, heavy emphasis is placed on payment history and the amount of debt load. If you are constantly late in making payments, and owe a lot of money to different creditors, your credit rating obviously suffers.

Why is good credit important?

Simply put, the better your credit score, the less money you pay in interest.  This is because the lower your credit score, the higher rate of interest you pay.  Let's look at an example.  You secure a 30 year mortgage on a home.  This is what payments will look like.

FICO score      APR                  Monthly payment *
760-850           6.237%            $1,845
700-759           6.459%            $1,888
660-699           6.743%            $1,944
620-659           7.553%            $2,109
580-619           9.124%            $2,441
500-579           10.107%          $2,656

Lets do the math - with a credit score of 500-579, you pay $9,732.00 more per year on a 30 year mortgage.  That totals to $291,960.00 over a 30 year period. The reverse would be true if your score was 760-850.  Another consideration is the amount of points you pay.  With a lower credit score, you may have to pay a higher percentage of points to get the interest rate at an acceptable level.

So what exactly is a credit report?

By now, you may be asking yourself "what is a credit report and how do I get a copy?" Your credit report is essentially your credit history. The credit report details what credit cards you have open, what type of loans you have (school loans, mortgages, car loans), how long you have had the loans, and the amount of the outstanding balances (i.e. what is still unpaid). The credit report lists not only credit card debt, but also lists debt from utility companies, phone companies, hospitals, banks, etc. The credit report then uses these facts to generate your credit score. A computer-based program then derives your credit score by using numerous factors in a complex formula. The computer takes into account factors such as how long it takes to pay your bills, how much debt you have, the number of inquiries into your credit history, liens, and bankruptcies. The computer spits out a three-digit number, typically between 500-800, which is entered on the report. The higher the number, the better the score.

Credit can be fragile

One of the biggest issues facing consumers is by the use of computers tracking their every move in the credit arena.  Credit websites are full of examples of people who have had their credit badly damaged because of clerical errors.  Something as simple as an error in data input can harm you.  There have been instances of people moving or changing addresses, and not receiving bills and statements, and are penalized because they may miss a payment or not be aware that one even exists.  Credit card companies are very particular on terms.  Grace periods are out of the question, and being even an hour late getting a payment in is cause for upping your annual percentage rate.  It is vastly important that you keep your eye on all statements, pay all bills on time, and do everything you can to protect your credit.

The importance of good credit cannot be stressed enough.  Knowing how your score is calculated is essential, and keeping a finger on the pulse of any creditors is almost mandatory.  Now that you have a fair idea of credit and how it is rated, visit these following sites to check your credit rating.

           * Equifax: http://www.equifax.com/
           * Experian: http://www.experian.com/
           * Trans Union: http://www.transunion.com/

 

*source: myfico.com