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Tuesday, February 18, 2014

Credit me this, credit me that: Who's afraid of the big bad credit cat?

It IS about the money.
Americans have trillions of dollars of outstanding debt

By Dan M. Shahar
Ever got hit for a loan by anyone you know? Did you give in? Why, or why not?

Maybe you did lend someone money before. It probably took them forever to repay it. Made for some awkward gatherings, didn’t it? The wise sloth actually says lend money to a friend and never expect to see it again.

This is why most people borrow from financial institutions instead. In fact, more and more Americans are falling into debt every year. Nerd Wallet estimates American consumers are in the red by $11.36 trillion. The amazing thing is that the figure actually went down by 1% from last year’s.

Are there any signs that we’re stopping from borrowing money any time soon? Hell, no. Nearly 20 million Americans start college every year. At least 60% will have student loans to cover costs. The young professionals are applying for credit cards by the truckload. They’re starting families and taking out mortgages. They’re financing cars.

What does this all mean?

Well, apart from the obvious (debts and more debts), it means you need to take care of your credit rating. That is, if you hope to snag that car, house and whatever else needs the power of plastic to own.

3 little numbers could make your dreams come true

credit score
The cost of debt usually declines as credit score rises

Well, to be honest, they could also make your dreams die a premature death. Like what happened to Louise and her husband. All they ever wanted was to move out of their dingy apartment. Have a house of their own. Finally start a family. They applied for a housing loan. They were declined. Dreams down the drain, I tell you. The end came in 3 little numbers: Five. Eight. Zero. 580.

What is it? Their credit score.

Credit scores influence the credit that is available to you. It affects not just the amount you’re eligible for. It also influences loan terms, interest rates and a whole lot of other things. This is why it’s VITALLY IMPORTANT to your credit health.

Why are you being assigned a number?

Remember that borrowing friend scenario? You choose to lend money based on your personal assessment of your friend’s capacity to pay it back.

Does he have a job? Is he earning enough to actually be able to pay you back? Has he borrowed money before? These are just some questions you consider. For financial institutions, that’s called a “risk assessment.” Except banks don’t personally know you. So the assessment is done more objectively.

That’s through a credit report. It summarizes your credit risks. It is based on a snapshot of your credit report at a particular period; 90% of US institutions use software developed by FICO (Fair Isaac and Company) for this assessment. The scores range from 300 to 850.

To avail of a credit card with reasonably good interest rates, you need a score of at least 650. Need a car loan? Some places will let you have one with a credit score as low as 500. Most require 700 or above, though. That house? 620 – 640. Although some lenders may be persuaded to qualify you even with just 580. Obviously, Louise wasn’t very persuasive.

The 3 stooges of credit ratings

choose one
Credit rating agency scores have a big impact on credit markets

It is important to note though, that there isn’t just one department churning out these scores. In the US, there are actually three: Equifax, Experian and TransUnion.

What does this mean?

Well, simply that not all the data gathered is going to be the same across all three bureaus. It affects the way the information is displayed, too.

These are usually the same among the 3, according to freescore.com:
  • Name
  • Date of birth
  • Social Security number
  • Current and former addresses
  • Employment information
  • Address, telephone number and email address.
  • Former and current employers
  • Spouse's name, Social Security number and employment data
  • Bankruptcies, judgments, other legal actions and public information
  • Payment history
  • Current debt ratio
  • Longevity of credit history
  • Combined balance owed and credit limit on open revolving credit cards
  • Credit application inquiries
But even if they’re the same, the points attached to each may be different. And the variance may be as high as 40 points!

How else are they different?
  • Experian uses the PLUS score method. It explains what credit scores mean. It also lets you know how to improve it.
  • Equifax uses Credit Score to assess risk. The score range is 280 to 850. Higher credit score = lower credit risk.
  • TransUnion use TransRisk. This one is very similar to FICO. The score range is also 300-850.
Did I say you need just 3 little numbers? I lied.

You actually need 3 three little numbers. One from each bureau. That gives your “true credit standing.” The upside is all 3 also give out a free 3-in-1 credit report.

So you want that house and car? Start hoping that your numbers are high enough and attractive enough. Otherwise, it’s a bust.

About by author: Dan M. Shahar is a huge fan of ball games and old movies. He's in love with facts and numbers, and will do his best to satisfy his customers. You can check his website WeSellWords for more articles like this.

Image license: Match Financial, CC BY 2.0; 2. Match Financial, CC BY 2.0;  maplegirlie, CC BY-ND 2.0