Personal Credit Ratings

Some investors may say that past business performance is not necessarily a guarantee of future performance; however this is not always the case. Your credit rating is an indicator of past borrowing and repayment performance, and this is why it is used to determine how likely it is that you can be expected to repay a new loan in full and on time. Your credit rating, which is a direct indication of your credit worthiness, helps a potential lender anticipate how reliable you will be in repaying any borrowed financing.

Lenders use your personal or "consumer" credit rating to determine their risk in loaning you money for a car, home, or other purchases, as well as what terms to impose on the financial transaction. For instance, if you want to purchase a home, depending on the economy, you could expect to pay anywhere between 5% and 10% depending on your credit score and the amount of your down payment. Someone with a strong credit rating would only pay 5%, while a person with a lower credit rating would pay 10% because he or she is perceived as being a greater credit risk. Depending on the amount of the loan, this could greatly affect the total interest that ultimately is paid to the financial institution. As your credit score improves, financing is easier to qualify for, and the terms of the loan (including the interest rate) will improve.

Lenders may also use personal credit scores to determine whether to loan to small businesses and corporations. Even if the business itself has an excellent business credit report and score, many types of loans require the personal guarantee of the owner(s). Typically, a lender will analyze the personal credit scores of all owners with 20% or more interest in the company as well as require them to personally guarantee any business loans with personal assets. So in order to qualify for the optimum business loans, it is critical that business owners have excellent personal as well as business credit scores.

Personal credit scores are based on the independent standards of the three major credit rating bureaus: Experian, Equifax, and TransUnion. Lenders average the fixed score from each of these bureaus to determine a borrower’s eligibility and terms of financing. The most common type of rating system is known as FICOR. However, there is also a new credit rating system that has been getting a lot of use lately called VantageScore^SM.

FICO™ Score

This credit rating system examines a variety of factors and assigns a point rating to each one. Each of the factors carries a different weight in the final score, and both positive and negative factors can affect that score:

• Payment History (35%) – This takes into consideration your ability to pay your debts in a timely manner. It reflects the number of past due items as well as how long they were delinquent. How long it’s been since these late payments were made as well as if any collection activity was initiated are also taken into account. Any public records such as bankruptcies, legal judgments, lawsuits, liens, and wage garnishment are also a factor.
• Current Total Debt (30%) – This takes into consideration the total amount of your accounts owed, including the number of accounts and the balance on each one. Each of these factors can greatly influence your FICO score. In addition, the credit bureaus will also look at the outstanding debt on your credit lines in proportion with the available credit.
• Length of Credit History (15%) – This takes into consideration how long each of your accounts have been opened and what type of activity these accounts have experienced.
• New Credit (10%) – This takes into consideration the number of new accounts your established recently as well as any credit inquiries from other lenders indicating that you have attempted to secure new lines of credit.
• Types of Credit (10%) – This takes into consideration the total number of different types of credit that you have secured, including revolving debt on credit cards and retail accounts.

Not all aspects of your personal life are considered when establishing your FICO score. Many personal factors, such as your age, race, ethnic background, religion, sex, and marital status, do not influence your score. Likewise, employment history, current employment, wages earned, and assets are NOT taken into consideration as part of your FICO score. However, these factors are factored in by potential lenders when evaluating your credit worthiness.

A FICO score can range anywhere from 300 to 900 points. The most qualified borrowers have a FICO rating of 750 or better. Borrowers can obtain loans with a minimum score of 650, but they will most likely pay more interest than they would if their score was higher. A person’s FICO score can change monthly, reflecting any changes to the criteria used to determine the score. For instance, if you pay down the balance of an outstanding loan, this may improve your score, while failing to make a required monthly payment will lower your score. A bankruptcy or judgment will also negatively impact your FICO score. Even applying for an additional credit card my lower your overall score because of the inquiry about your credit. Several websites, including BankRate.com (http://www.bankrate.com/brm/fico/calc.asp) offer easy-to-use tools to help you estimate your FICO score.

Monitoring Your FICO Score

It is strongly suggested that you monitor your FICO score periodically. This will make sure you are aware of any problems or errors that might come up so that you can correct them immediately. These types of error can range from minor (someone else’s credit card delinquency appearing on your credit report) to severe (criminal identity theft where someone else has used your credit to generate large sums of unpaid debt in your name).

Federal law provides every individual one free personal annual credit report that includes all the information being reported under your name and Social Security number. There are many websites that can provide you with this free information, including AnnualCreditReport.com (https://www.annualcreditreport.com/cra/index.jsp) . If you request a free credit report through a secure website such as this one, you will be able to obtain your credit information almost immediately. However this process can take up to two weeks if you prefer not to use the Internet and instead call their toll-free phone number to make your request.

Finally, you may want to consider using a commercial credit monitoring service in order to keep an eye on your FICO scores more closely. ScoreWatch™ from Equifax is one example of a company that provides a service to monitor your credit activity and notify you when any kind of change is made to your FICO score. The annual cost for services such as this one are approximately $80.

VantageScore

In 2006, for the first time, the three predominant credit reporting agencies – TransUnion, Equifax, and Experian – have come together to create an innovative rating system that is intended to make the credit rating process more objective and more simple. VantageScore is a rating system that generates scores from 501 to 990. The better your credit is, the higher your score will be. However, since VantageScore is still relatively a new system, it is too early to determine how lenders will respond. To learn more about VantageScore go to www.equifax.com/vantagescore/index.html.