Still clueless about credit scores? You are not alone

WASHINGTON — What’s the score with credit scores?

Most people don’t have a clue, according to the second annual survey commissioned by the Consumer Federation of America and credit card company Providian Financial. And that can be costly, especially when it comes to financing a house.

Someone applying for a $150,000, 30-year fixed-rate mortgage would be charged at least 7% if his credit score was below 620, if in fact he would qualify, according to the website https://www.myfico.com . But if the same borrower’s score was above 760 and all else was equal, the rate would drop to, say, 5.42%. (Interest rates fluctuate daily.)

The difference in the example is perhaps even more meaningful when you think of it in terms of dollars: At 7%, the monthly payment for principal and interest on a $150,000 loan is $998. But at 5.42%, the payment drops to $844. That’s a savings of $154 a month — or $1,848 a year.

Credit scores are not the same as credit reports. A credit report basically represents your financial history over time, whereas a credit score is a snapshot of your credit profile at a particular time. Scores are not stored in your file. Rather, they are generated on request and can change from day to day, depending on the latest information in your file.

Much like the bell curve, which can be used to grade students according to how well the class does as a whole, a credit score measures the relative risk a potential borrower represents as ranked against all others whose profiles are stored within a particular credit bureau’s files. And many businesses and creditors — not just mortgage companies — use them to determine not only what you’ll be charged, but also whether your business is wanted at all.

Consumer understanding of credit scores has improved somewhat since the first CFA-Providian study in July 2004. But according to the latest poll conducted in August on their behalf by the Opinion Research Corp., fewer than one in three people realize that a score measures their risk to the creditor.

And only 20% know that just making minimum payments on their accounts will actually lower their scores, even when the payments are made on time.

To help consumers better understand credit scores, how they work and how they can be improved, here’s a short quiz, based on one developed by the CFA and L.A.-based Providian. (The quiz is also available online at https://www.consumerfed.org/score .)

• True or false: A married couple has a combined credit score.

False. You cannot improve your credit by marrying someone with better credit than your own. Scores reflect your own past credit history, no one else’s. And when husband and wife apply for a mortgage, both their scores are checked by the lender. If one spouse’s score is significantly lower than the other’s, the rate quoted by the lender could be higher.

• True or false: Individuals have only one credit score.

False again. There are many types of scores, some of which have been developed for particular businesses, including the insurance and automobile sectors. Even utilities and cellphone companies are now using credit scoring.

Although the various models were developed by the Fair Isaac Corp., each one produces a different score. Consequently, if you are applying for financing, you’ll want the classic FICO scoring model created exclusively for the mortgage market.

• Which of the following factors influence your score: age, marital status, education, income, amount of debt related to income or whether you have maxed out your accounts?

Personal characteristics don’t count, so if you picked any of the first three, you guessed incorrectly. Mainly, your score reflects whether you pay on time and how well you use the credit granted to you.

The most effective step you can take to improve your score is to consistently make timely payments. If you’ve been late in the past, get current and stay current, and eventually, those previously tardy payments will count less and less against you.

Another important step: Don’t max out your credit cards. It is better to pay off debt than to move it around from one card to another.

However, it is better yet to pay your cards down to 30% of the credit available to you and keep them below that level.

• If your score is below a certain level, either you’ll be forced to pay a higher rate or you’ll be denied altogether. What is that level?

Scores range from a high of 850 to a low of 300. Typically, borrowers with scores above 760 are charged the lowest rates, and those between 700 and 760 are charged a little more.

But the odds that someone is a “bad payer” — a consumer with at least one 90-day late payment in his file — increase markedly below 700, so people with scores below that benchmark usually pay higher, subprime rates, if they are approved at all.

• People have the right to a free credit report once a year. Does that same privilege extend to credit scores?

Not necessarily. You have a right to see your score, as well as a list of reasons why your score was not as high as it could be, when you apply for a mortgage. Otherwise, you’ll have to pay a small fee.

Even if you don’t want or need to know your credit score now, it is wise to keep tabs on your credit file so you can make sure it is error-free when the time comes to apply for financing. It can take months to have mistakes removed from your records, so the sooner you act to expunge them, the better.

• Is it OK to open new credit accounts once I am approved for a mortgage?

No, not yet. Refrain from taking on any more credit until after you actually close on the loan.

A few days before settlement, your lender is likely to run another check on your credit and generate another score, just to make sure there’s been no significant change in your status. If you have run up more debt, the rate on your mortgage could change — so much so that you no longer qualify.

• Is there an ideal number of credit cards one person should have?

No. According to Craig Watts, public affairs manager at Fair Isaac, the FICO formula recognizes no single optimal number of credit cards for all consumers — and that’s a good thing. “The formula would be much less predictive if it were that simplistic,” he says.

People who are just starting out with credit are best served by taking on new credit slowly. For them, having one active card is probably best.

On the other hand, people who have been doing a good job of managing a variety of credit types for many years can safely handle several cards without changing their credit risk.