Understanding Credit Scores

A good credit score is important if you are planning to buy a car or purchase a home, and will need to apply for a loan or mortgage.  If you have won the lottery and have lots of cash and don’t need to borrow money, then you don’t have to obsess about your credit score, as many people do.

Most people understand that when you charge at a department store or buy gas and pay with a credit card, you are receiving credit.  That means you are financing the purchase for a certain amount of time. The credit you are getting allows you to buy something now and pay for it later.  To obtain this credit, you pay a premium, known as interest.

Banks and lenders like to give credit because they make huge amounts of money from interest payments.  The amount of interest they charge an individual is based on the person’s credit score.  This is a number that lenders use to assess your credit worthiness and it determines if they will provide you with a credit card or loan and at what interest rate.

Your credit report is maintained by three national credit-reporting agencies – Experian, Equifax, and TransUnion – that compile and report a surprising amount of information about you, including where you live and where you used to live, and where you have been employed.  Often, this information is out of date and in order to correct it, you have to write to the agencies and inform them of their errors.

Your credit report also contains your Social Security number, marital status, date of birth, and matters of public record, such as bankruptcies, tax liens, and any judgments filed against you.

The credit report also includes a list of creditors, banks and stores that have given you credit, and what you currently owe them.  It will include whether you paid your charge accounts and credit cards on time.  Most mortgage lenders, banks, credit unions, and finance companies will report information to the credit bureaus.

If you apply for too many credit cards in a short period to time, and too many inquiries are made, then lenders will red flag you and ask why you are applying for credit with so many lenders.  So, if you are shopping at The Gap and they offer you a credit card, and you apply, an inquiry is made on your credit report.  If you do this too many times, the number of inquiries made may hurt your credit score. 

Unsolicited credit cards that come in the mail, ones you did not apply for, are considered soft inquiries and will not count against you.

To track your credit score, you are entitled to a free copy of your credit report every year.  We have the Fair and Accurate Credit Transaction Act to thank for that.  The way to check your score for free is to go to:  www.annualcreditreport.com.  You can also call 877-322-8228, or request one by mail by writing to Annual Credit Report Request Service, P.O. Box 105281, Atlanta, GA 30348-5281.  If you request a credit report by mail, you must include a form with the request, which you can get from the Federal Trade Commission website at www.ftc.gov/credit.

Credit scores are most commonly calculated by Fair Isaac and Company (FICO). Your credit score, generally called a FICO score, is based on the following criteria: 

Your payment history – are you paying on a timely basis?Your outstanding debt – what percentage of the credit available to you are you using?Your credit history – how long have your accounts been open?Credit applications – have you had many inquiries in the last 12 months?New lines of credit – are there many new lines of credit that you have opened in the last 12 months?Your credit mix – what type of credit has been given to you?

Here’s an example of a low credit score and how much you would have to pay in interest.  The credit score is 590 and you want to borrow $25,000 to purchase a card on a five-year loan.  You should expect to pay close to 18% in interest.  Compare this to a credit score of 740, which would qualify you for a much lower rate.  Let’s suppose you qualified for an interest rate of 4%.  Over the life of the loan, a person with a credit score of 740 will pay about $9,000 less in interest than a person with a credit score of 590.  That’s a big difference.

The savings in interest is the reason why people try to repair their credit scores before they buy a big-ticket item, like a house or a car.  Anyone can write to the credit reporting agencies and explain errors and misinformation on their credit reports. 

Write a brief letter to each agency stating that there are errors on the credit report.  Include your name and social security number.  Enclose a copy of the credit report.  Circle the errors.  State specifically the information that is wrong.  List the items that are wrong. 

Don’t forget to say in the letter, “Please review this matter and remove the incorrect information.  Please notify me of the corrections you have made at the address at the top of this letter.”

Provide the credit reporting agency with a phone number where you can be reached if they have questions.

Here are the addresses where to send the letters:


PO Box 740241

Atlanta, GA 30374



Experian CBA

PO Box 2002

Allen, TX 75013



TransUnion LLC

Consumer Disclosure Center

PO Box 1000

Chester, PA 19022



To increase your credit score, pay your bills on time, make full payments when they are due, pay down your debt, and avoid applying for too many credit cards.  As an alternative to credit cards, spend only what you have by using a debit card issued by your bank.  If you do not qualify or are unbanked, you can obtain a prepaid debit card, and keep adding cash as you need to.  Branded prepaid debit cards are readily available with Visa and MasterCard logos.

Nowadays, there are many cash-based methods of payment available.  It is time to review your financial picture by learning as much as you can about credit and keeping your debt as low as possible.