Establishing and maintaining a good credit history is critical to saving hundreds – even thousands of dollars in interest when you are granted a loan. The higher your credit score, the lower your interest rate and subsequent payments will be.
Applying for a loan will typically involve looking at the applicant’s credit or FICO score. FICO stands for the Fair Isaac Corporation, a company that provides consulting and decision management systems. What do they have to do with you receiving a loan? Bill Fair and Earl Isaac developed the FICO scores as a method of measuring credit risks. Their system was introduced to the credit bureaus in 1981. The graph shows what percentages of your credit score are determined by the five factors used in determining a credit score.
Prior to 1981 when someone applied for a loan, the lending institution would tend to review credit worthiness on an individual basis. For example, if you had a well established history with your bank and maybe suffered a temporary financial setback that caused you to be delinquent on current loan payments but have now been able to establish your timely payments, the bank would consider your history and your extenuating circumstances and possibly grant you the loan. However with the wide-spread acceptance and implementation of the FICO method, most creditors look only at your credit score. If it does not fall into an acceptable range – which can vary by lender, you may not be approved regardless of your circumstances. Or if you are approved, you will pay for the loan with a higher interest rate.
| Courtesy of FICO, notice the difference in a mortgage payment on a $300,000 loan based on score: |
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To maintain a good credit rating, it is important to remember the following:
Pay all bills on time. For installment loans, remember that you are not reported delinquent to the credit bureau(s) until you have gone beyond 30 days.
With credit cards, try to utilize no more than 35% of your credit balances. Maxing out your credits cards will dramatically decrease your credit score. If you have not yet established credit, apply for a credit card. The length of time you have established your credit history is key in demonstrating your credit worthiness.
Be sure that you have signed up for the credit card insurance that generally states that if you lose your job (for reasons the creditor will define), your payments may be made up to a year. You may never have to use it, but it will maintain timely payments if you ever have to.
Always pay more than your minimum payment. The more you pay over the minimum payment, the quicker you will pay off the loan - and cut down considerably on the interest.
