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Dave Patterson and Erin Preston, a father-daughter team of Certified Financial Planner® licensees, provide thoughts and suggestions on a broad collection of personal finance topics.  Information provided in this BLOG is intended to be of a general nature and may not be appropriate for all situations.  Readers should consult with their own financial advisors before relying on any information contained herein.

Thursday, October 1, 2009

Managing Your Credit Score Part I

Most everyone understands that their credit rating is quite important when it comes to getting a car loan or mortgage. But are you aware that your credit score can have a huge impact on the cost of those loans and can affect other aspects of your finances as well?

Your credit report can be obtained free, annually, from each of the three major credit bureaus: TRW (Experian), Equifax and Trans-Union. Obtaining your credit score may or may not cost you a small fee. A number of services can be found online that will give you free reports from all three credit bureaus. Some of these services also typically offer a free credit report (including your credit score) that requires that you sign up for a credit-reporting service that must be cancelled within a specified number of days or you will be charged for the service. This is one way to obtain your credit score (also called a FICO score) for free. FICO stands for Fair Isaac & Company. Be aware that the credit scores you purchase may not be exactly the same as scores used in reporting your credit (FICO score). Be sure you are obtaining your FICO score and not some other proprietary credit score that may be calculated differently and possibly even on a different scale.

FICO scores generally range from 300 to 850. The three credit bureaus use different methods to calculate credit scores, so your scores will vary slightly from one bureau to the next.

A study was conducted of the relationship between credit scores and the likelihood of a delinquent account. For example, the odds of someone with a credit score of 595 having a delinquent account were 2.25 to one. The odds for someone with a credit score of 780 defaulting on an account are 576 to 1, according to the study. Therefore, it’s easy to understand that your credit score is a major factor in determining whether or not you can obtain a loan.

In addition to your credit score affecting your ability to obtain a loan, it is a major factor in determining the interest rate you will have to pay. The higher your credit score the lower your interest rate. Each lender has its own tiers with associated rates, so it pays to shop around for a mortgage.

The higher your credit score, the more you you’ll pay for mortgages, car loans, cell phones and credit cards. But that’s not all! Insurance companies use credit scores to determine the risk of losses from homeowner and auto policies. Premiums can be substantially higher for those with low credit scores. The insurance companies claim the studies have shown that losses are inversely proportional to individuals’ credit scores (i.e., the lower your credit score the higher the risk of a claim and vice versa.)
The Michigan Court of Appeals recently ruled that state regulators can prohibit insurers from using customers' credit scores to determine home and auto insurance rates. That 2-1 decision reversed a previous 2005 ruling by a lower judge who allowed companies to keep using credit scores.
Ken Ross, Michigan’s Office of Financial and Insurance Regulation commissioner, has stated that this method of assessing risk is discriminatory and against the law. Earlier this year, Ross had rejected rate hikes ranging from 2 to 10 percent proposed by seven insurers who were citing credit scores as a factor. An appeal to the State Supreme Court was still pending in May.
Regardless of whether or not insurers can continue using credit scores in determining premiums, a high credit score can save you plenty and ensure that financing is available should you need it. A little work at maintaining good credit will provide a good return on your effort.
In our next post we’ll discuss things you need to do in order to maximize your credit score.


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