Understanding Credit Scores

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Understanding Credit Scores

As the economy continues down its volatile path, keeping a watchful eye on your credit score is more important than ever. But simply watching your credit score isn't enough. You have to understand how credit scores work and how using your credit can affect them. This is easier said than done.

Understanding how credit scores work is complicated. When you apply for credit, increase a credit line or make a late payment—all these things can affect your score. And to make it even more complicated, these actions have different effects on lower credit scores than they do on higher ones.

To better illustrate the point, let's look at some actual credit scores* and see how "credit events" can affect each differently. For obvious reasons of privacy, let's just call them "Jane and John Doe." Jane has always been great with her money and how she uses credit. Her score is 793. John, on the other hand, has had some trouble in the past with how he deals with money. His score is only 576.

Getting a New Credit Card — Jane 793 to 791, -2 points. John 576 to 557, -19 points.
Let's start by looking at what happens to the Does' credit when they add a new card with a $15,000 limit to what they already have. In Jane's case, she already has several credit cards and adding a new one barely changes her score, but not so for poor John. If John could even qualify for a new card, it will cost him 19 points against his credit.

Increase Credit Limit of Credit Cards by $10,000 —Jane 793 no change. John 576 to 612, +36 points.
Jane already has several credit card accounts, so increasing her credit limit by $10,000 doesn't change her score because her credit card utilization is already 0%. As for John, the extra $10,000 in credit line lowers his credit card utilization significantly and therefore boosts his score by 36 points!

Closing Oldest Account — Jane 793 no change. John 576 to 558, -18 points.
Established credit accounts are great for showing credit history and adding numbers to your score. For Jane, who has a long line of established credit, closing an old account has little or no effect. But for John the results are damaging. Closing his oldest account costs him 18 points because he loses any good credit attached to it. And it doesn't work both ways. If you close an account with a mediocre history... that history stays with your credit score.

Paying Off All Credit Card Debt — Jane 793 no change. John 576 to 615, +39 points.
Jane always, always pays off her credit card debt and carries no balance on her cards. This doesn't change a thing for her. But for John, it's a big benefit. Paying off all of his credit card debt raises his score by 39 big points and goes a long way to establishing good credit.

Increase Credit Card Debt by $10,000 — Jane 793 to 769, -24. John 576 to 556, -20 points.
This is where Jane's good habits actually hurt her score more than John's. By increasing her credit card debt by $10,000, her score drops more than John's because she had no debt prior to the $10,000, whereas John has some preexisting debt.

Allow 1 Monthly Account To Become 30 Day Past Due — Jane 793 to 759, -34. John 576 to 558, -18 points.
Poor Jane, she's had a bad month or two and misses her first monthly payment. For John, this is old school. This will hurt Jane more than John because a 30-day delinquency for someone with no prior problems is an early warning of default risk and changes her score by -34 points, almost double the points that John will lose.

Have On-Time Credit History for 24 Months — Jane 793 no change. John 576 to 595, +19 points.
This is John's moment to shine. By paying his bills on time for 24 months he can increase his credit score by 19 points. Paying bills on time for 24 months does not affect Jane's score because she has paid her bills on time for over 10 years, establishing a great credit rating.

Credit and credit scores have always been cryptic and difficult for consumers to understand. Whether you're like Jane or John Doe, it's important to get control of your credit, especially in these days of economic uncertainty. Hopefully by demystifying the information, you can see how using credit wisely can go a long way toward building your financial health.

The credit score changes in this article are based on Credit Karma's personalized credit simulator and are not guaranteed to occur.

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All Comments

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8 Contributions
26 People Helped

Helpful to 13 out of 18 people

I subscribe to this site, Quizzle, Credit.com and a paid subscription to Identityguard....all 4 have credit simulators and all 4 give different results. 

On identity guard i get all 3 of my credit scores and with their credit simulator they use actual credit information (which is shows with the computation) for comparison:

On ck I put the add a new credit card and my score went down by 10 points, on Identity guard, the same thing increased my score by 21 points through experian, 16 through equifax and 12 through transunion. So how can ck (who uses transunion) show my score going down by 10 points wheras identity guard shows an increase? 

Another comparison:

On identity guard i entered paying all my accounts on time for 12 months, it showed an increase to my experian score of over 100 points! on ck...no change! 

so who should i trust? or should i just wait for a year and figure it out?

2 Contributions
20 People Helped

Helpful to 19 out of 27 people

I have a question:

My current credit score is 693 (it was 739 in December, 724 in January)(recent credit card balance payment not reflected)

I have a US Bank Visa Platinum Credit card with a $450 credit limit and currently owe a balance of $225.16. I have always made on time and over the minimum payments on it.

I received a pre-approved offer from Capital One for a Platinum Master Card Credit Card with a $500 credit limit, applied, was accepted and have activated my new card. They are offering me the option of transferring my US Bank Visa balance to my Capital One Master Card.

"Transfer a balance at your existing purchase rate. No Fee! "

My existing purchase rate is 0% (introductory rate) which changes to 22.9% in July 2010.

I can pay the balance off before then.

Would this be a wise move and make any improvements to my credit score, etc.?

Thanks in advance for any advice.

It would be wise to accept that card if you feel that you can pay off the balance by July. The real question is, do you want the 22.9% after your introductory rate. This rate will stand and if you close your card, it will hurt your credit score. Paying your balance off and having another credit line will help your score.

Review by
CK Moderator

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4 Contributions
9 People Helped
Helpful to 6 out of 10 people

I would suggest to get the Cap 1 for zero interest --- BUT!  Beware do not continue to spend just because you have another card.  If you get the Cap 1 --- cancel the US Bank. OR,  get the Cap 1 --- put the US card up (out of reach) ---- pay off the Cap 1 ASAP --- cancel the Cap 1 -- and us your US Bank.  If you look I believe you will find the interest rate  w/Cap 1 will be much higher than the US card.

Don't know what state you are in --- if you are looking for a great banking experiece with much lower fees and interest, get out of the big banks and get into a Credit Union.  Lots will take customers 'off-the-street'.  After 40 years of 'regular' banks, I finally, moved to a CU and they make a whole lot of difference in your finances.  

Hope this helps you.


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1 Contribution
1 Person Helped
Helpful to 1 out of 1 people

Who cares about your credit score!?! Get out of debt ASAP. If the card helps, great, if not (or if it helps by < a month) it's probably not worth the paperwork. NOTE: when you pay off credit cards and close the accounts, it will ding your FICO score (I like Dave Ramsey's description of FICO: "your playing kissy face with the banks - I love debt score!"), but possibly not by much. I shut down three accounts recently (>$10k in limits total) and my score dropped a whopping 8 points.

Top Contributor
13 Contributions
47 People Helped

Helpful to 18 out of 26 people

this article is NOT informative. i recommend reading wikipedia articles on FICO and vantage scores

1 Contribution
8 People Helped

Helpful to 8 out of 9 people

I have 3 old (2 + years) collections on my report. Will paying them off immediately improve my score if I'm currently trying to get a home loan?

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1 Contribution
0 People Helped

Enter Your Reply

Yes, it wil, but I suggest you call te company and request a "pay and delete" to remove all of the negative reporting to the 3 bureaus, because  It worked for my fiance. Otherwise, it will remain for 7 years. All they want is their money so you should have no problem. Have them put it in writing.!!!

1 Contribution
7 People Helped

Helpful to 7 out of 9 people

I have a score of 737 and I have a one credit card balance of $8500. i am looking into buying a home after I safe the down payment. Should I pay off my $8500 dollar debt of my only one credit card first to better my score? Or should i focus on saving the down payment and pay off my debt after I get my first year taxes on my new house and continue paying the minumum payment?

8 Contributions
26 People Helped

Helpful to 8 out of 10 people

My credit score is 704.

My biggest problem is percent of on-time payments which is 98.35% and for which I received a grade of C. The last more than 30 days late was in April, 2009 (a complete oversight!) and the one prior in 12/2008.

Using the simulator, even adding 24 months of on-time payments did not change my score. Could this be correct? Or is this a simulator problem, i.e., a bug?

Btw, this is for a Bank of America credit card. For some reason this card has given me trouble in paying it on occasion, even though it never has much if any balance on it. (Totally my fault.)

But, to avoid costly oversights like the one in April I went to the BofA site to set up autopay. I have autopay for my other two cards. I couldn't find it, called up and then, finally, was told they didn't offer signing up for autopay on-line; that they have to send me a form that I fill out and then mail back into them!

I couldn't believe it. Of course, with autopay you lose the "opportunity" to be late. I.e., you've eliminated the opportunity to pay the bank its outrageous later fees.

Several days ago I received the autopay form. I filled it out and then searched around for the return envelop. There was none, let alone a pre-stamped one! Only a one line sentence on the 2nd page giving the address where to send it. This is why I'v gotten to despise BofA.

In some cases, you need the past delinquencies to fall off your credit report before the score could improve.

Review by
CK Moderator

1 Contribution
4 People Helped

Helpful to 4 out of 6 people

I checked my credit report on ProtectMyID.com with their 3-Bureau in one report and each credit bureau is reporting my score at 673 but CK is reporting 616? Why such the big difference?

They are probably using a credit scoring model different from ours. We use the Transrisk model from TransUnion.

Review by
CK Moderator

1 Contribution
3 People Helped

Helpful to 3 out of 4 people

My bankruptcy was discharged 2/09 purchase a automobile 4/09 making payments on time for a year. Currently my score is 595 will it be over 600 if I make next month payment.

Review by
CK Moderator

3 Contributions
4 People Helped

Helpful to 2 out of 2 people

I need to get a Consolidated loan (not thru a debt consolidation company though, no way). How can I get someone to help me out, I could pay my bills much easier, but they don't seem to care or understand this at all. Nobody seems to want to help now-a-days.

If you have good credit consider, P2P lenders like Lending Club or Prosper . With poor credit, your options are limited.

Review by
CK Moderator

1 Contribution
5 People Helped

Helpful to 5 out of 9 people

How accurate is the credit score simulator? I made some mistakes in 2008, and by November 08 I was back on track. I know repairing/rebuilding takes time and I’ve acted responsibly over the last 15 months. I use three credit cards and pay off the balances each month. My score is 685 and I was able to refinance at a favorable interest rate. According to the simulator, by adding my new mortgage amount (not on report just yet), indicating that I’ll pay off all credit card balances and having an on time payment record for an additional 3 months it should increase to 752. Is this true? Would it really increase that much in such a short time? Thanks in advance.

Over 200 factors go into computing your credit score. Your score should go up to what is simulated as long as you continue your trend of paying off your balances each month and mortgage payments when they start.

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CK Moderator

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8 Contributions
26 People Helped
Helpful to 12 out of 14 people

I must repectfully differ with the moderator wrt the accuracy of the simulator. In my post of Nov 12 I said: "Using the simulator, even adding 24 months of on-time payments did not change my score. Could this be correct? Or is this a simulator problem, i.e., a bug?"

The moderator's reply, below, was that this could happen if old items needed to fall off.

I couldn't believe this. And in fact it wasn't true. In January my score shot up to 732, back to 728 in Feb (one hard inquiry, what bs to lower your score for this!) and now is 744, and NOTHING has dropped off my report.

The more I think about the credit scores and how they are determined (from reading creditkarma and other sources), the more skeptical I am that they validly reflect one's credit worthiness and in fact that they can be reasonably empirically validated by the agencies. I have a highly technical background and also, having been around too many smart people, don't accept the "these have been done by very smart people." So, for example, were the derivative models that helped cause our recent economic crash. Brought to us in part by the "best and brightest" quants on wall street. As was the demise of Long Term Capital Management with 2 Nobel prize winners! Confirmed idiocy by smart people is a well-established fact of life.

I'd like to go into specific detail now about inadequacies in the scoring models as I see it (some of which have been brought up by others) but, unfortunately, it's off to work. Need to make those payments!

Dropping off means the effect on your score not the actual removal of an items from your credit report. For example, the hard inquiry may still be on your report but the effect has been removed from your credit score calculation.

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CK Moderator

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