The intricacies of the credit system and how your credit score and credit report are calculated is a dull subject for most consumers. Getting a handle on how this all works while in your 20's can set you on a path towards a stable financial future.
A credit report shows your payment history, which credit accounts are open in your name, how much credit has been extended to you, and other financial details. Experian, TransUnion, and Equifax are the three major credit bureaus that track all the information and organize it into your credit report. Each bureau's report may be slightly different, but for the most part they should be the same.
A Federal Trade Commission study in 2012 found that errors in a credit report affected 20 percent of consumers, and that one in 20 could wind up paying more for certain financial products (e.g., insurance, car loans) as a result. Disputing the errors can pay off, according to the study, and credit reports were changed for about 80 percent of consumers who reported mistakes. Clearly, it's important to keep tabs on your credit report. You can request a copy from each bureau once a year by visiting AnnualCreditRepot.com. Spread out your requests so that you can get a free copy every four months. If you see something that doesn't look right, follow the FTC's guide to correcting it.
If you requested a copy of your credit report and expected to see a score, you may be in for a surprise: It isn't there. That's because a credit report and a credit score are not the same thing. The data in your credit report are used to determine how much of a risk you are, which is presented as a credit score (denoted in points), but that number is not integral to your credit report.
The three primary credit bureaus as well as lenders (such as big banks), specialized credit reporting agencies (e.g., for mortgages), and vendors of financial products (e.g., insurance) analyze your credit report and calculate a credit score based on their own interpretation of the data and scoring model. As a result, you actually have many different credit scores. That said, the majority of lenders base their decisions on how much to lend and at what interest rate on credit scores generated by Fair Isaac Corporation's (FICO) algorithm.
Some credit card providers, such as Barclays and Discover, now show you a FICO score for free and notify you when it changes. Another option for monitoring your credit -- at no charge -- is CreditKarma, which shows your TransUnion and Equifax scores, which are calculated using the proprietary VantageScore 3.0 that was created by the three major credit bureaus. CreditKarma lets you compare reports from both bureaus side-by-side to check for discrepancies. There are other free options, but proceed with care. Many companies upsell related services, some offer paid subscriptions following "free trials," some are dinged by past customers.
Credit scores are calculated differently depending on who is doing the calculation; even FICO changes its formula occasionally (i.e., "FICO Score 9" was just released). Still, you can get a general idea of how FICO arrives at a credit score by perusing this outline.
According to FICO, your payment history is the primary factor affecting your credit score. Being a few days late isn't likely to kill your score, although you'll probably have to pay a late fee. A payment that is more than 30 days late, however, could shave 90 to 110 points from your total, regardless how high it was to start. A drop of that magnitude, myFICO points out, will cost you more than $10,000 on a 30-year, fixed-rate $150,000 mortgage.
Your score is also influenced by the average length of time your credit lines have been open. This is why it's important to get a credit card as early as possible and to leave accounts open unless you absolutely need to close them (or if you're paying an annual fee but not using the card). While you may want to cut up a card so you won't be tempted to use it, the better plan is to leave it in a drawer so your credit history continues to grow.
If you don't already have a credit card it's time to get one. You'll be building your credit history to show future lenders that you can be responsible. Getting started may require piggybacking on a parent's account by becoming an authorized user or by opening a secured card that's guaranteed by bank deposits, much like a debit card. In order to build a good credit score, you want to use less than 30 percent of your credit limit. This means that if your credit limit is $500, you don't want to have more than $150 of expenses on the card at any time.
Unless you plan to take out a car loan or mortgage in the next couple of years, don't overthink your credit score. It's not something that needs a daily check, or even monthly, for that matter. FICO's loan savings calculator shows how a credit score affects the interest rates a borrower is charged for loans. You'll notice that rates are grouped into credit-score ranges. As long as you're in one of the higher tiers you'll get a good rate. Bragging rights aside, there's no added bonus for having a "perfect" score.
If you find yourself stuck juggling a car payment, student loans, credit card debt, and whatever, remember that you're not alone. Consumer Credit Counseling Services offers free counseling and planning sessions with a credit and debt counselor. This service may be able to help you consolidate your debt into one low monthly payment or walk you through the steps needed to get back in the black.
