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720 – 850: Excellent
It is estimated that slightly less than 50% of the population has an excellent credit score. This is a group of people who have generally been at their current job (or current line of work) for more than 2 years. These people pay at least the minimum payments on their debts on time every month. These people generally carry a balance of less than 30% of their available revolving credit (i.e. credit cards), and they do not open new credit accounts frequently, or have many credit inquiries.
680 – 719: Good
This group contains approximately 14% of the population. These people may be doing almost everything right, but have a lowered score because of one or more minor issues. Perhaps one of their credit cards has a high balance. They may have been late on a payment in the last 2 years, or may have had a number of recent credit inquiries.
620 – 679: Average
It is interesting that this group is called average, who make up about 11% of the population. About 64% of Americans have better credit scores than people in this group. Things that people commonly do to end up in this category are to open up new credit accounts. Perhaps these people like to save 15% off their first purchase at a department store, or they wish to take advantage of low introductory rates for balance transfers on credit cards. These people may have large debt loads from car loans or student loans. They may also have too many credit cards and/or have high balances on those cards. Being late or missing minimum payments may also contribute to these lower scores.
580 – 619: Poor
This group contains about 10% of Americans who likely have a combination of factors listed in the “Average” categories. This group of people may have a very difficult time obtaining credit for car loans and mortgages.
Below 580: Bad
This group contains the bottom 15% of the population. This group likely has a combination of factors described in the “Average” group, plus a foreclosure or bankruptcy on their report. Most credit issues can be cleaned up over time; however, foreclosures and bankruptcies tend to damage credit scores for many years, if not permanently.
As of this writing, the graph on the previous page (from myfico.com) represents the most recent distribution of basic FICO® credit scores across the United States.
The average (mean) FICO® score in the United States in 2015 was 695.
Luckily, for most Americans, it is possible to increase their credit score with a few easy steps. Some credit scores can go up quickly, while others may take a little more time to resolve. We will cover these steps a little later, but first it is useful to know WHY we may want to increase our credit scores.
Staying with the above example, we know that lenders base their pre-approval amounts on the debt-to-income ratio:
Minimum Monthly Payments on Debt ÷ Monthly Gross Income = Debt-to-Income Ratio
This critical ratio shows the borrower’s ability to take on more debt. Mortgage lenders generally will not lend more than what would constitute 28% of a person’s monthly gross income. If there is other debt, mortgage lenders will generally not originate a loan that causes a borrower’s total debt-to-income ratio to exceed 36% (mortgage plus other debts).
As previously shown in the table, a person’s monthly mortgage payment on a given property can vary dramatically based on his or her credit score. The borrowers with higher credit scores are charged a lower mortgage rate, which means their monthly payment is lower for any given loan amount. People with a FICO® score above 760 can borrow up to $360,000 and have their monthly payment be the same as an individual with a FICO® score below 640 who borrows $300,000.
In other words, people with better credit scores can borrow more money with a lower interest rate than those with less desirable credit scores. People with excellent credit scores may be able to afford a more expensive property than those with the same income, but lower credit scores.
In addition to that, banks may require larger down payments from those individuals who are seen as a credit risk. If a borrower’s credit score were improved, he or she may be able to borrow more money for a lower interest rate and less money down on a property. Taking a few steps to improve a credit score can be well worth it!
Payment History – 35% of Credit Score
This category is weighted the most heavily and includes factors such as:
Did the amounts paid at least cover the minimum monthly payments?
Are accounts up to date?
Were there “slow pays”? (payments past due dates)
Were there missed payments?
With revolving credit, the minimum monthly payment must be paid on time each month. Unlike some loans, borrowers cannot make a double payment one month, and then skip the next. If a consumer is not able to make the minimum monthly payment on time every month, it is a good idea to call the credit company and try to set up a better payment plan.
Amounts Owed – 30% of Credit Score
“Amounts owed” is a complex set of criteria. The actual dollar figure owed is only one facet of this portion of the credit score. While the total amount owed is certainly important, a critical component of this category is the Credit Ratio. Simply stated, credit ratio is the credit balance divided by the credit limit:
Credit Balance ÷ Credit Limit = Credit Ratio
<30% = Low Risk (Ideal)
30-49% = Medium Risk
50-75% = High Risk
100% or more = Very High Risk
What if a consumer has more than one credit card? What if the credit card does not have a pre-set limit? What if the consumer has “maxed out” one credit card, but has zero balances on other cards?
These are common questions that are difficult to answer without knowing the exact formulas used by the credit reporting bureaus. Many experts deduce that not only does the overall credit ratio matter, but also the individual credit ratios.
Length of Credit History – 15% of Credit Score
How long has the consumer had credit accounts? How old is the average account? How old is the newest account?
If a consumer frequently opens and closes credit accounts, it is detrimental to their credit score. To optimize this category, credit accounts should be 5 years old or older. Taking advantage of an introductory credit card offer to transfer balances may save money, but it could hurt a credit score.
Consumers may need to take out new loans to buy a car or finance dental braces requiring new accounts to be opened. If at all possible, consumers interested in maximizing their credit score are best off attempting to keep longstanding credit cards open, rather than ditching them for new accounts. More about new credit cards is covered in the next section.
Rather than rushing to open a new credit card with a low introductory interest rate, try calling credit card companies that have open accounts to negotiate interest rates. It has been estimated that credit card companies pay hundreds of dollars on average to acquire a new customer. Companies may be willing to go to great lengths to keep existing customers! A quick phone call may result in a reduced interest rate, or even matching a 0% balance transfer offer!
IMPROVE YOUR CREDIT SCORES
Here are some ways to improve a credit score:
Be sure to make at least the minimum monthly payments on time every time
Do not let credit accounts go to a collection department or be sold to a collection company
Limit the number of open credit accounts to between 3 and 5 accounts
Keep credit balances low (or zero) on all open accounts
Try to keep old credit card accounts open
Keep credit inquiries to a minimum
Do not close credit accounts until the balances are paid off in full
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