Conscientious high school and college students will put hours of work into improving their Grade Point Averages (GPAs), a score that determines where they rank academically among their student peers. However, many don’t realize the importance of another score that may weigh equally on their future: their credit score.
“A credit score is a number that represents the credit worthiness of a person — the likelihood that a person will pay his or her debts,” says Staci Mintz, director of 1st Choice Credit Counseling and Education. A debt is money owed to a lender, such as a bank or utility company.
Getting to Know FICO
Credit scores are determined by a person’s credit history. When a person uses credit, such as making a purchase using a credit card or paying a bill, the lender sends information on payment history and balances to a credit-reporting agency. The three main credit-reporting agencies are Equifax, Experian and TransUnion. The information supplied by lenders comprises a person’s credit history and is contained in an individual’s credit report.
“The credit history information in a credit report is run through a mathematical algorithm created by FICO [a company in Minneapolis that provides analytics like credit scoring] to generate a credit score,” says Anthony Sprauve, spokesperson for MyFico.com, the educational website of FICO’s consumer division. A FICO credit score ranges from 300 to 850. “The higher a person’s FICO score, the better interest rates [the price borrowers pay for the use of money they do not own] they will get on credit cards, loans and mortgages, potentially saving them large amounts of money over the life of their loan,” adds Sprauve.
Five categories of data in a credit report are used to calculate a credit score. Each is weighed differently in importance. According to FICO, generally speaking 35% of the score comes from payment history information. This includes past payment information of various accounts. It also includes any negative activity, such as bills that have not been paid, how long these bills have been delinquent, and how much money is delinquent.
Delinquent or not, the amount owed to lenders is the second most important category, accounting for 30% of the score. Data in this category includes the number of accounts that are open with balances and the amounts that are owed on the accounts.
Next, length of credit history determines 15% of the score. The last two categories, accounting for 10% each of the score, are new credit, which looks at recently opened accounts, and types of credit used, which looks at what types of accounts are opened. While this breakdown is for the general population, some groups — for example, individuals who have not been using credit for a long time — may be weighed differently, according to FICO.
Sprauve offers the following advice for all people hoping to boost their credit scores: Pay bills on time, keep balances low and open new credit only when necessary.
Credit scores are given to individuals older than 18, who have had a credit card in their name for more than six months. Building a strong credit history and obtaining a solid score are important goals even for young people. “Young people should start a credit history as soon as possible. You can be denied a job on account of your credit report, particularly in the banking industry or in most government positions. A good credit history will also save money by enabling lower interest rates,” says Doug Young, director of the HSBC National Center for Economic and Financial Education at the Council for Economic Education.
‘Unavailable’ Credit History
Despite its importance, building a credit history is not as easy as it may seem. A recent law called the Credit CARD Act of 2009 maintains that a person must be 21 years old to get a credit card, unless an adult cosigns for the credit card or the individual produces proof of sufficient income to repay any loans. “This [law] has proven frustrating for me, because I do not want to ask someone to cosign for me, and my relatively low student income is not substantial enough,” says Sergio Portesan, an entering freshman at Colorado College. The 18-year-old applied for a card advertised for students, but was declined on the basis of having “limited or unavailable” credit history, he says.
Portesan has applied for reconsideration, but if that doesn’t work, he will apply for a secure credit card, a credit card that requires a deposit, to begin building credit history. “Building a good credit history is important to me,” says Portesan. “Credit affects a lot of things, so my goal is to establish a strong credit history while I am young and relatively unburdened, so I don’t have to worry about it in the future when the stakes are higher.”
Mintz of 1st Choice Credit Counseling and Education offers several tips for young people over 18 who are interested in beginning and building good credit history. For those who have a credit card, she suggests that students seek to pay as much of the balance as possible each month, “never paying only the minimum.” She also warns against lending credit cards or credit card numbers to others.
For teens like Portesan, who are having trouble getting their first credit cards, she says, “Build your savings. Down payments and deposits are helpful when applying for credit with little or no credit history. Talk with a representative from your bank about credit card options.” Secured credit cards or credit cards obtained by a parent cosigning also build credit history. “If used wisely, this can help,” Mintz adds.
What is a credit score, and why is it important to your financial future?
How can you boost your credit score?
How can teens effectively build their credit histories, even if they can’t get their own credit cards?