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Your Credit Score is About to Become More Valuable

by Ryan Guina

Your credit score is about to get a boost in value, at least as long as it is reasonably good. Because of the current economic crisis, many lenders are tightening their lending requirements, and having a higher credit score will make it easier for you to get a loan in this environment.

Why are loans becoming more difficult and expensive to obtain? Cash flow. One of the current problems facing our economy is that many financial institutions bet heavily on mortgage backed assets which have lost a lot of value. This means many banks have less money coming in, which decreases their cash reserves and their ability to create new loans.

What does this mean for the average business or consumer? Fewer and more expensive loans. Banks are required to keep a certain amount of cash reserves on hand. When their reserves run low, they are less willing to hand out money, and when they do, they want a better likelihood of payoff. That means banks are going to be less likely to make loans to those with lower scores and more likely to lend to people with higher credit scores. Banks may also charge more for loans in the mean time.

Your credit score is a valuable asset

Your credit score is valuable for many reasons, primarily because it allows you to more easily obtain credit and at lower interest rates. But a high credit score can also help your qualify for a cell phone, avoid paying a deposit when you get utilities for your home or apartment, and get lower insurance premiums. Your credit score can also be used by potential employers and landlords as a screening tool. Your credit score is valuable, and you should treat it like an asset and work to improve your score.

How your credit score is determined

Your FICO credit score is determined by several factors, each of which are weighted according to a formula set by FICO, and posted at the myFICO website.

This chart breaks down the components of your FICO score.

How your credit score is determined

How you can improve your credit score

The best place to start to improve your credit score is to become current and stay current on every billing cycle. As you can see from the chart above, your credit score is comprised of several  variables. Once you are current, you want to work on the areas that count the most. Being current on your payments improves your payment history, which makes up 35% of your score. After that, you want to pay down your loans which reduces the amounts owed (30% of your score).

Canceling credit cards can negatively affect your credit score if you aren’t careful. Canceling credit cards can reduce the length of your credit history (15% of your score) and increase your credit utilization (the amount of money you owe compared to the amount of available credit).

Applying for new credit cards or loans can reduce your score as can the type of credit you utilize. Some forms of credit are considered better than others. For example, a car loan or a mortgage is better perceived than a store credit card or a payday loan.

How long will the restricted lending practices last?

With the current credit market currently unstable, no one really knows. Right now a lot of it depends on the bailout bill and whether or not it gets passed. The goal of the bailout bill is to give banks more money to make more loans.

Right now the best thing consumers can do is to work to improve their credit score. you never know when you will need it, and it’s always a good thing to have!


Published or updated February 26, 2011.
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{ 13 comments… read them below or add one }

1 Ron@TheWisdomJournal

This is a great idea, taking a proactive approach in this depressed credit market. Your credit score is just a representation of your reputation, and a good reputation with creditors will help make sure you’re able to obtain credit in the event you need it.

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2 Kristen

Thank you for pointing out that canceling credit cards will negatively impact your credit score. The concept that canceling accounts is a good thing is running rampant through the population, mostly because people don’t understand how credit scores are calculated.

The other point of advice I would offer up is that if someone is going to have trouble paying a bill, they should contact their creditor and explain the situation ASAP. Some creditors will work with consumers to temporarily modify a payment or due date if someone is facing a financial hardship beyond their control. The worst thing someone can do is just not pay the bill and end up with a late payment of charge off on their credit report.

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3 Mr. ToughMoneyLove

Ryan – Although your point and analysis are very good, I am afraid that messages like this reinforce the mistaken belief among American consumers that they can borrow their way out of financial trouble. If any economic time says “increase your net worth to prepare for the worst”, this is it.

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4 Leah S

What IS a good credit score? What score makes lenders go “hmm…” and “no way!” all the way to “you’ll get this loan in a heartbeat, you’ve got a fabulous FICO!”

I know there’s the general guidelines – anybody over 720 is great, over 800 is excellent. But where do lenders draw the line? “Anybody over XXX automatically gets a loan”?

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5 Dividend Growth Investor

I hope that in this tough environment people with good credit are not placed in the same group as the ones with poor credit.

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6 Ryan

Mr. Tough Money Love: I don’t mean to imply that anyone can borrow their way out of trouble – uncontrolled borrowing is what got out country’s economy in this mess int he first place.

My point is simply that with fewer banks willing to make loans, a high credit score is more valuable because it will help those who can responsibly use the loan obtain the money they need.

I agree with your assessment to increase your networth, so long as it is not simply paper net worth, which is how many of these financial institutions became so “valuable.”

To me the current economy says take care of your personal finances in every way possible: fortify your savings and emergency fund, improve your credit score, pay down debt more quickly etc. Now is probably not the time to make large financial gambles.

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7 Ryan

Leah S: A good credit score is generally considered anything around 660 or higher. How high your score needs to be depends on many factors, such as how much you are trying to borrow, etc.

I think lenders have a sliding scale of who they will lend money to and at which interest rates. Generally the higher your credit score, the better your rates. Some companies have a lower limit for credit scores at which they will not make loans. I think that depends on the lender, but usually in the lower 500s is very bad and you may have a hard time finding anyone willing to lend money to you.

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8 Zhu

I was reading your other article as well on how canceling credit card can affect a report and I must say that I find it extremely stupid (the fact it can affect your credit score, not your article! :lol:)

People can think the less credit cards they have, the more they can manage them efficiently, the less they would get in debt etc. But on the other side, credit card companies push and increase limits! My $500 limit credit card I got when I first came to Canada has been increase to $7500 in 3 years. I do NOT need that money. But hey, as my bank told me, I’m lucky to have an high limit… Weird society that pushes people to consume always more.

Sorry for the side rant!

I agree that credit history is more important nowadays, lenders will be very careful.

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9 Daphne Lim

Great site Ryan, and it’s a good article. I’m not living in the US so the details don’t apply to me, but I like your pro-active stance in showing people that we do have control over our financial status and should in fact learn the rules of the money game. Keep up the good work!

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10 Kristen

Another comment about credit scores, and in particular the mention of a score of 660. If someone is applying for a government-insured mortgage (such as a VA loan or an FHA loan), and their credit score is below 660, that person/couple is required to get housing counseling from a HUD approved agency before they can take out the mortgage. 660 is the line where the government starts to go, “Hmmm …”

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11 Ryan

Daphne: Being proactive with your finances is the best thing one can do in times of economic uncertainty. One can’t rely on government bailouts or other events to take care of them!

Kristen: Thanks for sharing. I didn’t realize that! :)

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12 Sportskater

I have a question. I have a good credit score (730). I also have a lot of credit and a substantial amount of debt. I am using 57% of my available credit. I have just been turned down for a car loan. I’m confused. I have never made a late payment on my mortgage, installment loans or revolving credit cards and over the last year have made some significant reduction in my debt. Should I try again through a bank that I have used for car loans years ago? What can I do to keep from getting turned down again? The lease runs out on my car soon and I have got to be prepared to buy or lease again.

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13 Ryan

Sportskater, You are able to get a free copy of your credit report any time you are turned down for a loan, so now may be a good time to get that so you can find out why you were declined. You can also contact the lender and ask them. It may be that your credit utilization is too high for them, or there may be other factors. You will definitely want to know more information before going in for your next loan application.

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