Why Your Credit Score REALLY Matters

by : Tabitha Naylor

Think that your credit scores don't matter? If so, you are not alone. The problem with this thinking is that it is VERY flawed. Your FICO scores affect nearly all of your financial dealings, from the annual percentage rate that you pay on your credit card to whether you are able to purchase a cell phone.

Your credit score is of particular interest to lending institutions. Nearly 75 percent of all lenders assess this score when determining whether to grant a loan. If you plan on ever buying a house and car, or need to FICO scores to be examined very carefully.

A bad score (anything under 600) will make most lenders think twice - lenders certainly don't want to lend to individuals who appear to be a risky proposition. A low score could keep you from getting that dream house or purchasing a new car, and could even threaten the possibility of getting a job.

So what's the easiest way to ensure that you'll be approved for a loan? Become familiar with your credit report and your scores. The more you learn about these two items, the less likely you'll be of becoming a member of the "high risk group."

Why all the fuss over simple three-digit numbers?

Examining how your FICO scores are calculated may provide insight as to why some lenders may choose to deny your loan application. Your FICO score (FICO, by the way, stands for Fair Isaac Company-the institution that created and compiles the score) is calculated using data pulled from your financial records. This information includes: the number and types of credit cards you use, your payment history, the amount of money you owe, the number of years you've had a history on file, and whether you have any new credit.

Which of these things carries the most weight in determining your scores?

Approximately 35% of your credit score is determined by your payment history. Your payment history refers to a number of factors, including the different types of payments you regularly make (examples of payments include standard major credit cards, department store credit cards, mortgages, and car loans), and whether you have missed or paid late on any payments. Included in your payment history is information regarding any bankruptcies, liens, judgments, foreclosures, wage garnishments, or law suits that have been recorded. If your payment history reflects that you don't have much debt and usually pay your bills on time, you can expect your credit score to be the upper brackets (680 and above). Conversely, if your payment history reflects a pattern of missed or late payments, and you have a significant amount of outstanding debt, you can expect your credit score to be much lower.

Another large chunk of your FICO scores is determined by the total amount of debt you carry. This includes all the amounts you owe on different credit card accounts, as well as installment payments such as car or student loans. Also of importance is the different kind of debt you carry, such as credit card debt versus mortgage and car loan payments. If you carry a lot of debt on a high-interest, long-standing credit card account, you can expect this scenario to hurt your credit score significantly. Another scenario, however, could have a much different effect on your credit score. For instance, an individual who pays a lot, mostly due to their mortgage payment, will likely have a higher credit score than a person who pays a lot because of debt on their credit card.

So, now that you have a better idea of how your scores are calculated, you can understand why lending institutions may be wary in lending to individuals or small business with low FICO scores. Lenders can interpret a low number to mean that you have a high amount of outstanding debt and a history of missing payments (or even worse, both). Unfortunately, even if you are approved for a loan, chances are that you will be forced to take a high interest rate as a result of it.

Before you approach a lender, be certain you know your credit history and scores. By knowing this information, you grant yourself the opportunity to clear up any discrepancies or inaccuracies that may be on your credit report before your score is scrutinized by lenders.