Risk Assessment: Is more credit in the cards for you?

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Your credit score, a rating of your creditworthiness, affects whether your application for a mortgage or other loan will be accepted. It also helps lenders decide at what level to peg interest rates. More industries than ever are using this score, including insurance providers, apartment managers, cellular phone operators and even utilities. Score too low and you may be asked for a deposit before the electric company turns on the lights.

“We’ve proven the correlation between how you handle money and whether you will file an expensive insurance claim,” says Craig Watts, public affairs manager for the Fair Isaac Corp., the company that pioneered credit risk scoring. “How we treat money comes from very basic parts deep inside each of us. Conservative consumers look after their car, their home, their health more carefully,” he says

When you use a credit card, take out a loan, or pay bills, transaction by transaction you are creating a financial portrait of your life. This financial portrait is, of course, your credit report. Using information in your credit report, credit bureaus calculate a convenient three-digit number—a credit score—which places you in a certain risk category. In essence, by comparing your borrowing history with that of other Americans, credit bureaus determine statistically how likely you are to repay a loan.

Consumers have more than one credit score. However, the one most widely used (consulted by an estimated 75 percent of institutional lenders)—the one synonymous with “credit score”— is the FICO score, created by Fair Isaac.

FICO scores range from 300 to 850. The higher the score, the lower the risk. Each of the “big three” credit-reporting agencies—Experian, Equifax and TransUnion—generates its own FICO score, based on the specific credit information they have on file about you. To further muddy the waters, the FICO score at each bureau has its own moniker: at Equifax, it’s the Beacon; at Experian, the Experian/Fair Isaac Risk Model; and at TransUnion, the Empirica. At www.myfico.com you can purchase all three FICO scores and credit reports for $44.85, along with an explanation of the positive and negative factors affecting your score. (By Federal law, consumers have free annual access to their credit reports but not their credit scores. Visit www.annualcreditreport.com.)

Your credit score is based only on the information in your credit file that concerns credit management. FICO breaks these data into five categories: payment history, amounts owed, length of credit history, types of credit used and new credit. Not included in your credit score is personal data, such as how long you’ve lived at your present address or worked at your present job. The Consumer Credit Protection Act forbids credit scoring from considering your race, color, gender, sex, marital status and national origin.

“[Credit scoring] has done two marvelous things for the consumer,” says Watts. “It has greatly accelerated the speed with which lenders make credit decisions.”

Credit scores have also made these decisions objective and fair. “In the old days, you were judged by local bankers, who maybe made decisions based on where you lived, on who your relatives were, or perhaps the color of your skin,” Watts says.

Questions such as “If I cancel this credit card, will it hurt my score?” tend to oversimplify this complex risk equation. “As people have more access to information, people spend too much time micromanaging their credit score,” Watts says.

There are three credit management skills that will aid consumers in improving their score, according to Watts: paying bills on time, keeping balances low and acquiring new credit only when they really need it. “Those are the main routes to getting a really terrific credit score because they represent more responsible credit behavior,” Watts says. Demonstrate that you can be a good borrower and the best offers will come your way.