We each have an easy reason to avoid credit errors. Mistakes of one sort or another can lower credit scores and thus raise the interest costs for homes, cars, and credit cards. The good news is that unexpected dings can be largely avoided.
Credit score basics
A credit score is simply a way to judge everyone’s credit report by the same criteria, an effort to introduce fairness into the lending system. Credit scores are not based on income. Instead they look at borrowing and ask how we use credit and how well we keep our promise to repay. Typical scores range from 300 (woeful) to 850 (fantastic) but some scoring systems use a somewhat different range.
There are five basic factors used to determine credit scores according to Fair Isaac, a pioneer in the field and developer of the FICO-brand credit score.
- How much do we owe (30 percent)? Credit scores go up as credit usage go down. For example, if you have a $5,000 line of credit and pay off the balance each month that’s great. If you have $4,900 outstanding for months on end that’s not good, it shows to much credit utilization.
- How do you pay (35 percent)? This is a factor you can easily control. Just pay bills on time and in full.
- What type of credit do you use (10 percent)? Credit scoring models favor a mix of credit usage. You’ll get a higher score if you have both revolving credit accounts such as credit cards as well as installment debt with regular payments for such things as homes and cars.
- How long have you been using credit (15 percent)? This measure looks at your use of credit over the long term. The longer you have been using credit the more credit reports can track your credit usage.
- Are you looking for new credit: (10 percent)? We all open credit accounts from time-to-time but borrowers who suddenly open a number of credit accounts or greatly increase lines of credit will see credit scores decline. Why? Because such activity may suggest a need for credit to keep afloat and that makes lenders nervous.
Protect credit score
It makes sense to think of good credit scores as money in the bank – that’s really what they are, money that comes from lower interest costs. The big question is how do you protect your credit score. The most basic steps to protect your credit score look like this:
First, pay all bills on time and in full
Yup, something as easy as good bill-paying can help your credit scores. This strategy will give you high marks in the “how do you pay” category as well as save money that might be needlessly spent spent on late fees and other penalties. This is a quick and easy way to affect your credit score.
Second, you must have savings
If you have savings you have the capacity to pay bills if an emergency expense arises. The Federal Reserve estimates that 40% of us “cannot cover a $400 emergency expense, or would do so by borrowing or selling something.” As it happens, the typical payday loan is about $400, a high-cost form of borrowing you want to avoid.
Set up a savings plan. Collect pocket change, skip an expensive coffee every morning, and eat-in more often. You will quickly be able to put $400 in the bank – or more.
Third, engage in credit monitoring
A 2013 study by the Federal Trade Commission (FTC) found that because of credit errors “one in 20 consumers had a maximum score change of more than 25 points and only one in 250 consumers had a maximum score change of more than 100 points.” Even a small credit score reduction can move your interest costs higher.
“These are eye-opening numbers for American consumers,” said Howard Shelanski, Director of the FTC’s Bureau of Economics. “The results of this first-of-its-kind study make it clear that consumers should check their credit reports regularly. If they don’t, they are potentially putting their pocketbooks at risk.”
There are now a number of commercial credit monitoring services. Consumers should look carefully at such services, how much they cost per month, and how they can be terminated. Alternatively, you can check your own credit.
There are also a number of sites online which provide free credit scores. With these programs you do not have to buy other products and services, the scores are really free. The value of these systems is that if you see a sudden drop in your score it can pay to check your credit report.
Consumers can get free copies of their credit reports from AnnualCreditReport.com. Under government rules you can get one free copy of your credit report every 12 months from each of the three major credit reporting agencies (CRAs) – Equifax, Experian, and TransUnion.
You can get all three at once or – as a do-it-yourself monitoring program — you can get one free report from a different CRA every four months. Look for factual errors and for items which are out-of-date, generally seven years for most credit bills, foreclosures and Chapter 13 bankruptcies as well as ten years for Chapter 7 bankruptcies. Judgments are different. A judgment can potentially stay on your credit report for decades, depending on the state where it was recorded and whether it has been renewed.
Get a line-of-credit for your checking account
Bounced checks can cost big money in terms of bank fees and extra merchant charges. It can also hurt your credit. A study by the Center for Responsible Lending (CRL) found that “banks with over $1 billion in assets collected more than $11.45 billion in overdraft and non-sufficient funds (NSF) in 2017.”
Beat the system. Get a line-of-credit for your checking account. Sometimes such lines are free, sometimes there’s a small annual cost, say $25. If you use the line there will be an interest cost but you’ll avoid late fees and credit dings.