What I Use: Credit Reports and Credit Scores

This is part of a series of posts detailing all of the tools I use in my financial ecosystem, from accounts to services. I’ll explain what I use and why.

Like it or not, credit is a very important part of our financial lives. I’m not talking about credit cards, specifically, but credit in the broad sense of the word. In order to get any type of loan from a bank, whether it be a credit card, mortgage, car loan or something else, the entity loaning you the money will often look at your credit report and credit score. These days, even potential employers, with your permission, may pull your credit report to determine if you’re the kind of person they want to hire. It’s important to understand exactly what credit reports and credit scores are and how they can affect you.

In short, a credit report is a collection of information that makes up your credit history. Current and past accounts will be listed, along with opened and closed dates. Payment history on each account will show if you made payments on time, and if not, how late your payments were. Inquiries that have been made into your credit report will also be shown. Age of your credit history and accounts is on this report, as well. This information is reported by the lenders to the three major credit bureaus: Equifax, Experian and TransUnion. Some lenders may not report to all three bureaus. The first time you obtain some type of credit, your credit report will be established and this history will continue building throughout your life. Many people, myself included, before I understood better, think that credit reports are evil, and the entire industry is a scam. As it turns out, these credit bureaus simply collection information and put it into a report that is easy to understand.

Lets move on to credit scores. There are a number of different credit scores floating around these days. The most well known is probably the FICO score. Each of the three bureaus has their own score, as well. Be careful when thinking about purchasing your credit score from the three bureaus, as the ones they sell to consumers are not always the same as the one they’re selling to lenders. What exactly are these scores, you ask? Essentially they’re a numeric representation of your credit worthiness. They take the information from one of your three credit reports and turn it into a number that estimates the likelihood that you will default on your accounts. The lower the number, the less credit-worthy you are. How they determine this is based off of a number of factors, some of which we know, some we don’t. Since these credit scores are products that companies are selling, the exact formulas they use aren’t 100% available to us. We do know some of the major factors that play a part, however. FICO, for example, have published the general categories that make up your score, and how they are weighted. The most important thing you can do to improve or maintain your credit score is to pay your bills on time. The next most important thing is that you don’t run up the balances on your credit cards. Like with the reports, there’s nothing sinister going on here. This is simply a tool used to determine if you’ll be a good debtor or not. If you were going to lend someone else money, you would most likely want to know that your chances of getting your money back were good. The same thing goes for credit card companies, banks, mortgage companies, etc.

Now that we have a basic understanding of credit reports and credit scores, lets take a look at some ways we, as consumers, can keep track of these things and use them to our advantage.

Credit Reports: AnnualCreditReport.com

Thanks to some legislation that went into effect several years back, each of the three bureaus is required to give you a free copy of your credit report once a year. If you haven’t checked your credit report in a while, or at all, I advise you to head over to AnnualCreditReport.com right away. Not only is it good to know what’s in there, but it’s important to check for incorrect information or fraudulent activity. In the past, I’ve typically pulled all three of these reports at the same time. Starting this year, however, I’ve decided to spread them out over a year (one every four months), so that I have a better chance of spotting anything fishy. Unfortunately, as I mentioned earlier, not everyone reports to all three bureaus, so there’s still a chance something bad might go unnoticed for a while. You’ll want to look closely at the accounts listed and make sure that: 1. They are all accounts that were opened by you and 2. They don’t have any incorrect information, such as missed payments. If something doesn’t look right, each report has a section on how to handle incorrect or fraudulent information.

Credit Scores: credit.com, Credit Karma and Credit Sesame

These sites are totally free and will each give you a rough estimate of what they think your credit score is by looking at one of your credit reports. They do what is known as a “soft pull” of you credit report, so it won’t count against you or hurt your credit score in the process. credit.com gives you a letter grade, along with a range that your score would fall into, Credit Sesame gives you a score, and Credit Karma actually gives you two different scores. Understand that none of these is the true FICO score that is most widely used, and they all vary dramatically. For example, credit.com has me as an A (750-850), Credit Karma has me at 718 and Credit Sesame, a 785. I just happen to know that as of last week, my FICO score based on my Experian report is a 798, so you can see the disparity. Don’t think of these scores as completely accurate, but use them as guides to give you an idea of where you stand. If you really want to know your scores, you’ll most likely want to purchase them from myFICO.com. As for the benefits of these free sites, I really like credit.com and Credit Karma because they each break down your score into categories and offer advice on how to improve. Credit Sesame has started doing this as well, but it’s not nearly as robust as the other two.

Right about now, you’re probably wondering why you should care about your credit score at all. Well, in reality, you probably won’t need to for the most part. However, if you’re planning on taking on new debt, such as car loan or mortgage, and you want to get the best rates, you’ll want the highest credit score you can get. Maybe that means delaying the loan application until you can pay off your credit cards, which will dramatically affect your score. We (hopefully) won’t need to take on any new loans any time soon, so for me, monitoring my scores is just something I do for fun. There’s no way that one year ago, I would have ever put “credit scores” and “fun” in the same sentence.

Image: jannoon028 / FreeDigitalPhotos.net

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Money Monday – August 15th, 2010

This week on Money Monday, get some information about credit cards, learn how to save some cash on your electric bill and your car, and more.

  • Get Rich Slowly gives some suggestions for lowering your electric bill.
  • I’ve Paid For This Twice Already has some tips for saving money on your car.
  • Is it possible to attain the coveted 850 credit score? MintLife Blog has the answer.
  • If you’re under 21 and to establish some credit, Smart Credit Blog will tell you what you need to do.
  • Wise Bread has five lessons us normal folk can learn from millionaires.
  • If you want to take a vacation, but travel really isn’t in the budget or you just don’t have the time, check out some staycation ideas from Currency.

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These Seemingly Bad Finance Moves are OK

Len Penzo dot Com outlines some finance moves that most people might consider poor decisions. Not always the case, as it turns out. My personal favorite:

2. Using credit cards. Many people unjustly fear credit cards. However, when used wisely and responsibly, credit cards provide valuable benefits that cash simply can’t including consumer protections, cash dividends and other rewards. They also help establish and build one’s credit score, which which is especially valuable when shopping for long-term credit to buy a home or car.

via 14 “Dubious” Personal Finance Moves It’s OK to Do. (Really!) « Len Penzo dot Com.

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When Is It Not Your Fault?

I found this post on Get Rich Slowly, which poses a very interesting question. It doesn’t offer up many answers, but rather gives you the chance to share your ideas.

It’s one thing to actually be just whining and complaining about your situation, but isn’t it just as bad to completely ignore or deny systemic roots of oppression and inequality? I guess what I’m trying to ask is: When is it not your fault?

Give it a read, it will give you something to think about.

via Ask the Readers: When Is It Not Your Fault?.

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Reaching Our Savings Goal

As of today, our savings account has just over $2,000 in it, a goal we’ve been working towards for nearly a year. I’ll get to how we did it in a moment, but first some history.

Last September, I began the long process of getting our finances under control. We had several thousand dollars in credit card debt that accumulated over the course of our marriage. For a long time we were living paycheck-to-paycheck and usually needed to put a little more on a credit card at the end of every month to cover expenses. It seemed that no matter how good things looked at the beginning of the month, the well was dry before the end. As mentioned previously, one of the most helpful instruments in correcting this course was Mint’s budgeting tool. Seeing how much money we were wasting on eating out and unnecessary shopping was eye-opening, to say the least.

I decided that I was fed up with living like that and that we were going to change, no matter what it took. We took a couple major steps to getting our credit card debt into a manageable state. These steps are not recommended by most people smarter than me, but at the time, I didn’t know any better. We took out a loan on my 401k and opened a new credit card that offered 0% interest for 12 months on balance transfers. We paid off some of it and moved the rest to the new card. Again, I don’t necessarily recommend these steps, but at the time I was desperate. We then stripped as much out of our monthly expenses as we could and were able to budget $300 per month to get the credit card paid down as quickly as possible. I’ll be honest, we were fortunate to hit this goal much sooner than originally anticipated, due to a substantial tax return that we weren’t expecting. The final nail in the credit card coffin came in May, when the final payment was made, bringing the balance to $0. I must admit, it was a pretty liberating feeling as I had not personally lived without credit card debt for almost ten years. I kind of wish I would have had someone take my picture as I clicked the button to make that final payment. Oh well.

Once this obstacle was out of the way, the next step was to divert all of the money from the credit card payment into our savings account. Most financial experts and blogs will emphasize the importance of establishing an emergency fund while paying off your debt, so that if something does come up, you aren’t just adding fuel to the fire. Because of the aforementioned 401k loan and tax return, we were able to create a small buffer in our checking account. This would hold us over, but it wasn’t quite the emergency fund we wanted and needed. So for the past three months, we’ve been putting the $300 that was previously budgeted for the credit card payment into the official emergency fund. So how did we hit our $2,000 goal so soon, you ask? Well, I get paid every two weeks, which means that twice a year I get an extra paycheck. When first setting up our budget in September, I determined it was easier to budget based on two paychecks each month, and this semi-annual “bonus” could be used for whatever was needed most at the time. In this case, all of it went into our emergency fund, helping us cross the savings finish line that much sooner. While a large portion of our debt was able to be squashed thanks to the 401k loan and the tax return, we wouldn’t be where we are now without lots of discipline and the right tools.

This doesn’t mean we’re done saving, however. A portion of that $300 will continue to go into the emergency fund, while we’re also saving for a couple other specific goals. I’ve already increase the amount of my emergency fund goal in Mint to $4,000. The journey isn’t over, this was just a big milestone.

Image: renjith krishnan / FreeDigitalPhotos.net

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