Is Your Credit Score Good Enough?

Last week, I got a panicked call from a client. She is buying a new condo in Miami, and has been busy working with a mortgage broker to wrap up the financing details.

“I am so upset,” she cried to me over the phone. “I don’t know what went wrong. I pay my bills as soon as they come in, but my credit score is only 815. I’m devastated!”

Once I got her calmed down, I explained to her that – lucky for her – she is far from having a problem. Her 815 is an amazingly great credit score and will ensure she gets the most competitive mortgage rates out there.

But once we confirmed that her mortgage application was on track (it was), we spent some time clearing up some popular misconceptions about credit scores, including some that can totally trip up even the most financially responsible consumers.

Here’s the top takeaways:

Different lenders and companies use different credit scoring systems

The raw data in your credit reports is gathered by credit bureaus like Equifax®, TransUnion® and Experian™. Since each bureau collects different information and prepares its own report, your credit report at one company will not be identical to your report at another. In addition to preparing a credit report, the credit bureaus also calculate your 3-digit credit score using analytical models developed by FICO® and VantageScore®. Each has a unique (and often secret) scoring methodology, further customized by the credit bureaus, so your credit score may differ somewhat from place to place.

So what’s a good credit score?

In any case, the top FICO and VantageScore grades are 850. So my client with an 815 credit score has already earned A+ status (generally, any FICO score of 800 or above is considered “exceptional”). Scoring an 850 instead of an 815 is not going to lower her mortgage rate, and is scarcely worth bothering over in my book. Nowadays, a score at the 780 level or higher should get you in the winner’s circle and qualify you for the best mortgage rates, so don’t sweat the details. If you track your credit score from month to month, you’ll note that it frequently moves up or down depending on your personal circumstances, so don’t be alarmed by minor fluctuations. For example, I just opened a new rewards credit card, and my score temporarily went down.

Why paying bills promptly is not enough

My client always pays her bills timely. That’s fantastic, as on-time payments account for 35% of your FICO score calculation and 40% of your VantageScore. But other factors also come into play. Ignore them at your peril. FICO and VantageScore put different weights on each factor, but regardless of the model being used, you need to pay attention to payment history, credit utilization, credit history, new credit, credit mix, and amounts owed.

How credit utilization can hurt you

What commonly trips up many consumers is closing unused accounts and high credit utilization. Credit utilization is a fraction measuring how much credit you’ve used divided by what’s available to you. It encompasses credit cards as well as personal lines of credit and even home equity lines (HELOCs). You want to keep the utilization at 30% or less in the aggregate and also on each account. Consumers with exceptional credit scores tend to keep it under 7%, so charging a lot even when you pay off bills at the end of the month can hurt you.

Here’s an example. Your credit card limit is $10,000. You charge $5,000 every month, but pay it off promptly each month. You’re proud of your timely payment record, but your credit score may still get dinged because you are utilizing 50% of your credit capacity each month. Seems unfair but that’s how the math works. “You may have a high utilization rate even if you pay your bill in full, say experts at Experian. Closing unused credit cards reduces credit capacity and can have the same negative effect.

What to do if your credit score needs some help

If your credit score does need a boost, there are plenty of resources available. First, check your credit score and review your credit reports to make sure what is being reported is accurate. You can get free credit reports from all 3 bureaus or visit AnnualCreditReport.com to learn more. To check your actual credit score, use a free service like CreditWise from Capital One (or another similar free service out there). It will show you where your score is weak, how to fix it, and even send you free alerts when there are changes you need to review.

The takeaway

If your credit score is 800 or better, congratulations! That places you in the “exceptional” range, and it may not be worth the time or effort to make it better. A score of 780 or higher should start qualifying you for the best mortgage rates, and that can save you thousands of dollars over time and make today’s historically steep rates a little more palatable. If your score is below that, it’s worth drilling down to see where your score is weaker and could use a little touch up. A premium credit score will save you on everything from mortgages to auto loans, from utility bills to cellphones, and even insurance premiums. You’ll find that even a little bit of time learning about how your credit score is calculated can starting saving you money right away.

 

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