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Thursday, December 19, 2002
Are You a Credit Risk? - Know The Score!
by Tim Liptrap
Did you know that your credit score tells a bank or credit card company how risky you are? Do you know what your score is?
A credit score is a risk management tool used by financial institutions before giving you a loan or extending credit. The higher your credit score offers a better chance that you will pay your debts. Higher scores often result in lower interest rates for auto, home loans and credit cards.
The largest group in the credit score business is Fair, Isaac & Company who produces the "FICO" scoring system that is used by more than 70% of all financial institutions. It is reported that 75% of all mortgages written in the United States use the FICO scoring system for loan approvals.
FICO scores are reported on a scale from 300 (bad) to 900 (excellent). Each individual earns a score. Credit scores based on five factors, payment history, amount owed, length of credit history, new credit and types of credit in use.
Payment History Lenders want to know about your history. It is an indicator of your payment habits. They look at late payments, loans in collection and bankruptcy. The more recent the incident or problem, the lower your score.
- Amount owed Can you afford to pay your bills?
Lenders look to make sure you are not over extended.
- Length of credit history
How long have you been making payments? The longer and more credit history that you have, the better your score.
- New credit
Are you always applying for new credit or charge cards? This could affect your score negatively.
- Types of credit in use
Certain types of loans can lower your score. Unsecured debt such as a personal loan or credit card will lower your score.
Lenders will often refer to FICO scores when authorizing your loan(s). Statistically, a person who has between a 700 - 749 score has a 5% delinquency rate. Which means that 5 out of 100 people will default on a loan, file for bankruptcy or be a full 90 days late on payment within the next two years. A person with a 499 or below will have an 87% delinquency rate. Being a late payer can actually cost you more money. If you have paid your bills on time, kept your debt down, you could literally save thousands of dollars on your next home loan.
According to the website (http://www.myfico.com) a 30 year, $100,000 fixed mortgage is currently available at a rate of 6.266% for people with scores between 720 and 850. If you have been delinquent in paying bills, have a lot of debt or a short credit history (score of 499 and below) that same loan will be offered to you at 9.615%. The rate change represents $81,304 over the life of the loan for a person who pays their bills late. This concept is the same for home equity loans, credit cards and auto loans.
Timothy Liptrap is the editor for "101 Financial Lessons" Newsletter. The newsletter is designed for teachers and parents to help teach children financial and money management skills.
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