Making Smarter Credit Decisions

Calculating Your Credit Score with FICO.

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We don’t pay much attention to our credit score. When you live debt-free and don’t borrow money, it becomes a non-issue. But we do realize that there are times in life when your credit score plays an important role in your future.

We helped our kids establish credit using a credit card secured by their bank accounts. They only used it for purchasing gas. Over time, the limited use of this credit card helped them establish a good credit score.

We always recommend the consistent use of a budgeting system to manage your finances.

Your credit score can also come into play when you’re renting an apartment, getting auto insurance and of course borrowing money for a car or house.

Factors that Affect Your Credit Score

Everyone has a credit score, and in the FICO model, that score is made up of several factors including the following:

  • The different types of credit you have – 10% of your credit score (mortgages, automobile loans, credit cards, student loans, personal loans, business loans)
  • The amount of new credit you have – 10% of your credit score
  • Your credit history – 15% of your credit score (the length of time your accounts have been active)
  • Outstanding balances – 30% of your credit score (sum of all outstanding balances)
  • Credit repayment history – 35% of your credit score (including liens, judgments, bankruptcy, overdue payments etc.)

It Begins with A Number – What’s Your Number?

With that in mind, it is much easier to understand where you are likely to fall behind when it comes to managing your credit, applying for new credit, and being approved. Credit scores change from time to time. It’s important to understand different credit scores according to different scoring models.

The main credit scoring model is FICO, and scores range from 300 on the low end to 850. It’s important to understand the impact of credit utilization on your personal financial status. People who pay scant attention to their credit score and management of their credit profile run the risk of insolvency.

Typically, both FICO and VantageScore 3.0 credit scores are as follows:

  • Bad Credit – less than 600
  • Poor Credit – between 600 and 649
  • Fair Credit – ranges between 650 and 699
  • Good Credit – between 700 and 749
  • Excellent Credit – above 750

Many folks are unaware that you can apply for a free credit report. Federal law mandates that the big 3 credit bureaus – Experian, Equifax, and TransUnion are required to provide 1 credit report to customers per year. It’s important to scrutinize these credit reports for any anomalies, errors, omissions etc.

If you happen to come across an account that you don’t recognize, it’s possible that your Social Security number and ID have been compromised. You will want to contact the requisite credit company and report any information that is false or inaccurate.

How are US consumers currently doing with regards to credit?

One of the most important determinants of credit utilization in an economy is the interest rate. Currently, the Federal Reserve Bank and the Federal Open Market Committee (FOMC) have pegged the interest rate at 1.00% – 1.25%. This is good news for people owing money, not so good for those who have money in savings accounts. As it stands, the lagging inflation figures and slow real wage growth have pushed back any possibility of a short-term rate hike. The Fed is targeting an inflation rate of 2%, and by July the year-on-year CPI is up at 1.6%.

Inflation is lagging because of slower than expected GDP growth, low fuel prices, and general uncertainty. If the Fed opts to pull the trigger, it risks raising the costs of borrowed capital which would be a disincentive to economic investment in the US. At the same time, this will cause the USD to appreciate (by draining liquidity from the economy). Currently, the US dollar index – a broad measure of the USD against multiple currencies – is trading at 93.42, for a slight 5-day gain of 0.34% heading into August 20, 2017. For the year to date, the US dollar index is down 8.75%.

The End of Year Fed Meeting

Fast-forward to the final Fed meeting of the year on December 13, 2017, there is a much stronger probability of the Fed raising interest rates in the region of 1.25% – 1.50%, currently at 37.6%. This bodes well for individuals currently seeking lines of credit. By locking in loans at competitive rates now, it is much more affordable to finance automobile purchases, mortgages, and other big-ticket items.

Calculating Your FICO Credit Score

Seven years ago, we looked into refinancing the small balance left on our “dream home.” With no credit cards and original financing by the previous owner, we ran into some roadblocks. A couple of the lenders we contacted said that we had “Insufficient Data” in our credit report and wouldn’t consider us for a loan.

We finally did find a source — our bank, where we had a long-standing history of deposits. But our options were limited. The same type of problem occurs with young people, those who are recently widowed or divorced, legal immigrants with no U.S. credit history and people who just prefer to deal in cash.

While we don’t encourage people to borrow money, most will have to do it at some point in their lives. Hopefully only for a home. Why is it that people who use credit cards, carry a monthly balance and pay lots of interest are considered better credit risks? Rather than people who pay their bills but like to spend cash or use debit cards? It’s just not fair! If only there was a company out there who considered people with timely bill payments, money in the bank and no credit card use a good bet for lending money. Such wasn’t the case seven years ago, but things are starting to change.

FICO and How it Works

Fair Isaac Corporation (FICO) the credit score people, unveiled a new FICO score in the last few years. It’s called the FICO Expansion (FICO-E) score and is based on the payment of rent and utilities and a clean checking account. Of the 215 million credit-eligible adults in the U.S., about 50 million have little or no information posted at any of the three major credit-reporting agencies — ExperianTransUnion or Equifax.

The FICO-E score is based on a combination of positive and negative nontraditional credit information. This includes clean checking accounts (no bounced checks), cell-phone accounts, landline phone accounts, utility payments, club memberships, judgments, liens, bankruptcy data and more.

As with the original FICO score, the expansion score ranges from 300 to 850 points. This score ranks consumers based on the likelihood that they will become severely  delinquent (over 90 days past due) in the next 24 months. The higher your score, the lower your default risk, and the more likely you are to receive a better interest rate.

To discover how widespread the use of the FICO-E score is, we had conversations with people at FICO and their public-relations agency, along with numerous banks. As it stands right now, not many banks utilize FICO-E scores. But we did find one credit-union chain that did. When FICO first released the availability of the information, they targeted car dealers and credit-card providers. In the past year the number of lenders using the new score has increased, but it is a far from widely accepted standard.

When to Check FICO

FICO representatives told us that consumers won’t be able to access their FICO-E score until a significant number of lenders are using it. So, you’ll have to wait a while to look it up on your own.

So, what good does it do you to know about the FICO-E score? Simply this: If you are in the market for a loan and don’t have a long and well-established credit history, ask the lenders if they would request a FICO-E score to establish your credit-worthiness. It’s that simple — just ask and you might get a better rate and save some cash. Now that’s fair.

If you want more tips on budgeting and managing your finances without debt, check out our 5-part budget series.

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