The 1-2-3 Money Plan Part 15

Basically, credit reports work like this: Companies you owe money to regularly report on you to three credit bureaus named Experian, Equifax, and TransUnion.

Did you pay your bills or didn't you? They report good stuff, such as on-time car payments, and bad stuff, such as failing to pay your cell-phone bill. Information on those reports translates into point values. Those points go into a math formula that spits out a three-digit number, your credit score. Lenders and others can look at that score and decide whether they want to do business with you. If they do, the scores might determine how good a deal they're willing to offer.

The process is more complicated than that, but that's the basic idea.

Today, it's a bit shocking how vital your credit information is. Consider that raising your credit scores from the low 600s to the high 600s could save more than $5,000 a year on a 30-year, $300,000 mortgage. Meanwhile, the same rise in scores on a three-year, $25,000 auto loan could save $700 a year, according to examples from the Consumer Federation of America.

That's a huge amount of money for most people.

The problem is many consumers find credit reports and credit scores confusing-and for good reason. Some of the details seem illogical.

Did you know?

* You could earn $1 million a year and have lousy credit. Credit scores don't even consider your income, your net worth, or how much money you have in the bank.

* People who pay their credit cards off in full every month and never miss a payment could have lower credit scores than people who have late payments and collections.

* Credit bureaus and other credit companies try to trick you into buying fake scores and near-worthless monitoring services.

Unfortunately, consumers still don't seem to know much about the topic of credit reports and scores, according to annual surveys by the Consumer Federation of America. Recent survey results are shown in Figure 6.1.

FIGURE 6.1 Understanding credit: by the numbers According to a survey of consumers by the Consumer Federation of America: * 31 percent of consumers know what a credit score means.

* 74 percent of people incorrectly think income affects credit scores.

* 79 percent incorrectly believe they can get their credit scores for free once a year. (They can get credit reports annually for free.) Source: Consumer Federation of America survey, 2007.

Why Your Credit Matters.

Paying more than you have to because you don't understand the basics of credit scoring is just wasteful. Plugging that leak of wasteful spending will allow many people to redirect money to other priorities.

Minding your credit is important for two basic reasons: You can save a lot of money, and you can discover ident.i.ty theft early.

Saving Money.

As I said at the start of this chapter, credit scores attempt to define whether lenders can trust you to pay back money you've borrowed. It's not a judgment about your personal integrity. It's solely about how the credit-scoring formula tries to predict whether you'll pay back loans or pay bills on time.

Your credit scores-the only ones that matter are your three FICO scores-might even help lower your rates on home and auto insurance, or land you a job, an apartment, or a cell-phone contract. That's because insurance companies, wireless carriers, and even some employers and landlords use credit scores in their evaluations of you.

So, even if you never borrow money, your credit rating is important.

Figure 6.2 shows how much lower your monthly mortgage payment might be if you have a good credit score. A person with a lousy score would pay about $11,000 a year more than someone with a great score.

Higher FICO credit scores mean lower payments.

FIGURE 6.2 Credit counts.

Ident.i.ty Theft.

You want to know early on if a thief has stolen your ident.i.ty and opened new credit accounts in your name. That's the most serious type of ident.i.ty theft. As we'll discuss later, having your credit card number ripped off isn't really that big a deal.

Monitoring your credit reports lets you catch the presence of fraudulent accounts early. You might not lose a lot of money with ident.i.ty theft because you have some consumer safeguards. But cleaning up the mess with banks and other creditors can be a huge ha.s.sle.

1. Get Your Credit Reports.

By federal law, you're allowed to check your three credit reports for free, but generally not your credit scores. Reports are more important because they are what scores are based on. You can get a report once a year from each of the three main credit bureaus. Some state laws give you the right to get them more often.

The three credit bureaus are Experian, Equifax, and TransUnion.

Accessing Your Report.

Go online to AnnualCreditReport.com, which is the only official site to get free credit reports.

Beware: The heavily advertised FreeCreditReport.com is an unconscionable attempt by the credit bureau Experian to confuse you and sell you services you don't need. Don't use that site.

Get all three reports, one from each of the three credit bureaus, if you meet the following criteria: * This is the first time you're accessing reports.

* You will need an important loan soon.

* You have reason to believe your ident.i.ty was stolen.

If this is routine credit checking, access just one report. It doesn't matter which one. Then check back every four months and access a different report. By staggering access to reports, you can check three times a year for free. Mark your calendar.

As of this writing, the procedure goes like this: Go to AnnualCreditReport.com and choose your state. Fill out the form with your personal information. You'll have to provide your Social Security number. If that makes you nervous, that's a good thing. You should be wary of giving it out. But in this case, it's OK.

Then, you'll encounter a security test-a short multiple-choice quiz involving your credit history. It might ask which bank holds your mortgage or ask you to identify a previous address. After that, skip advertis.e.m.e.nts for getting your credit score. View your report and print it. Or, save the report to a file on your computer.

Getting reports online is easiest. But you can do it by phone by calling 1-877-322-8228 or print an online form, fill it out, and mail it to: Annual Credit Report Request Service, P.O. Box 105281, Atlanta, GA, 30348-5281.

Reading the Report.

The report might appear intimidating at first, but read your way through it. After a while, it will seem like an episode of the 1950s TV series This Is Your Life, a diary of where you've been financially. It will have long-ago addresses, loans for cars you forgot about, department store charge cards you barely remember, and, maybe, late payments from a rough patch you went through years ago.

Don't be surprised that the bureaus have slightly different credit information in their reports. Some creditors don't report to all three bureaus.

Dispute Mistakes.

If you find serious mistakes that will affect your creditworthiness, such as credit accounts that aren't yours and incorrect negative information, follow the online instructions on how to dispute them.

If you see accurate negative information that is more than seven years old, you can dispute that too because negative information is supposed to expire off the report in that time. Bankruptcy is an exception. It can stay on credit reports for 10 years.

Don't worry too much about minor inaccuracies, such as typos or misspellings in former addresses. They don't figure into your credit score.

2. Get Your Credit Scores (Optional).

The only scores you need to worry about are your three FICO scores, which grade you on a scale of 300 to 850. Higher is better.

Others scores, some being sold by credit bureaus, are fake scores of dubious value. Some experts derisively call them FAKO scores. If the score you're retrieving doesn't specifically say it's a FICO score, it's probably not. Most lenders don't use anything but FICO-based scores. Alternative scores to FICO might become the standard in the future. But for now, FICO is all that really matters because the company that sells that score, Fair Isaac, has a virtual monopoly.

For routine monitoring, accessing your credit scores is optional. That's because scores are just based on what's in the report, and reports are free. Meanwhile, you'll probably have to pay for FICO credit scores.

But if you want or need scores, the easiest way to get them is to go online to MyFico.com and pay to view them. Two FICO scores are available, from Equifax and TransUnion. The third credit bureau, Experian, discontinued public access to its FICO credit score in early 2009. At the time of this writing, consumers no longer had access to their Experian FICO score. But they can still get their Experian credit report.

Remember, scores change all the time. You're just seeing a snapshot of your credit rating at that moment.

It's like an outdoor thermometer reading that changes from day to day. Unless something unusual happens, like a heat wave or snowstorm, the temperature reading will fluctuate within a relatively narrow range. Similarly, you won't have the exact same score every day because you're constantly using your credit, which affects the information being fed into the credit-scoring formulas. Unless something unusual happens, such as a late payment or bankruptcy, your credit score will fluctuate within a relatively narrow range.

If you've already seen your credit reports and the information is redundant, your scores will be similar. In that case, you can just retrieve one score because the others are likely to be similar.

Before you pay for scores at MyFico.com, do a quick search-engine query with the keywords "myfico.com" and "coupon code." You might find a discount code to get 10 percent to 20 percent off your order at MyFico.com.

If you don't want to pay for scores, you can get a general idea about your credit rating for free. Granted these are FAKO scores, but they can give you an idea of where you stand. Visit such Web sites as Quizzle.com, CreditKarma.com, Credit.com, and Bankrate.com. These sites offer free non-FICO scores and score simulators.

Get a CLUE: Your Insurance Report.

Did you know you also have the right to get an insurance report about yourself? It's what insurers will look at when deciding whether they want to insure you. It details your claims history for home and auto insurance. In other words, it notes the instances when you've filed a claim to get money from an insurer. It's called a CLUE report. The acronym stands for Comprehensive Loss Underwriting Exchange.

You're ent.i.tled to a free report once a year. Go to www.choicetrust.com and sign up to see your claim history. If you haven't filed claims in the past five years, you might not have a CLUE report. If you have filed claims, you might have two reports, one for home insurance and one for auto insurance. Be sure to request both.

Of course, you want to check for errors in your report that could result in being rejected for insurance or paying higher premiums than necessary.

For more information, see Fact Sheet 26 at the Privacy Rights Clearinghouse, found at www.privacyrights.org.

3. Improve Your Scores.

To spend smarter, which means getting the best deals and lower borrowing rates, you will have to raise your FICO scores into the 700s and ideally, beyond 750.

It helps to know what goes into a FICO score. The exact formula for calculating FICO credit scores is a secret, but we know that the biggest factor is your payment history. Paying your bills and loans on time affects 35 percent of your credit score. The amounts you owe account for 30 percent. The length of your credit history is 15 percent. Applying for new credit counts for 10 percent, as does the different types of credit you have. See Figure 6.3.

FIGURE 6.3 Paying your bills on time is the most important component of your credit score.

Source: MyFico.com Notice that your FICO score only includes the credit lines you have open and how you use them. If you're a cash-paying billionaire, you probably don't have good credit scores. Your maid and gardener might have better scores.

The following sections discuss ways to improve your scores.