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How Credit Scores Are Calculated

Many people know their exact credit score. If it is great, they wear it as a badge of honor of their financial prowess. “My credit score is 814,” they will say quite proudly.

Others who have a more colorful experience with credit, will wear it as a badge of dishonor. “My credit score is in the toilet,” they say with a glum look.

The fact is that credit scores are only a measure of how well a person can manage debt and contractual financial agreements.

Credit scores are calculated using these data points:

  1. Type of credit issued [Revolving debt (credit card) or Installment debt (anything with payments and a pay-off – car loan, boat loan, student loan, etc.]
  2. Age of the credit relationship
  3. Amount of credit one can obtain (total of all credit limits)
  4. Amount of credit one has consumed (percentage of total credit limit)
  5. Payment timeliness
  6. Requests for credit (“hard pulls” of credit)
  7. Outstanding judgments

Look at the list again. Does it include any relationship to how much money one might have in a savings account? Or any connection to a person’s net worth?

Here’s the fact: You could be a millionaire and have a terrible credit score.

How? By having zero credit relationships.

While a great credit score is more desirable than a terrible credit score, it is not the best indicator of financial success. Choose instead to make financial decisions about what best increases financial margin and net worth!

When Credit Scores Are Dumb

I recently went through a process that required my credit score to be checked. When I received it, I had to laugh out loud.

My credit score was extremely high, but there were reasons it wasn’t “perfect.” These reasons were listed on the document, and they furthered my belief that credit scores are a pretty dumb way to measure “financial healthiness.”

Here are some of the reasons my credit score wasn’t absolutely a perfect score:

  1. Lack of recent installment loans (I paid my house off in January!)
  2. Lack of long-term credit relationships(I paid off all my non-house debt in February 2004)
  3. Lack of credit accounts (Duh!)

Think about this for one minute. Most insurance companies establish premium rates based in large part on credit scores. Many employers check credit scores of potential employees.

Here’s what you must know: Your Credit Score would be more aptly named if it were called a “Debt Management Score.”

Your credit score has NOTHING to do with:

  1. The amount of money you have in a bank account
  2. The amount of money you have invested – for college, retirement, or dreams
  3. Other assets you own
  4. Your overall net worth

When people modify their behavior to keep paying debt payments “just to keep their credit scores high” – THAT is financially dumb behavior.

Your thoughts?

Have You Looked At Your Credit Report Lately?

Your credit report is used regularly to make decisions about you. Marketers use your credit report to determine the offer they will send to you. Insurance companies use it to establish premiums.

Since decisions are going to be made about you based on your credit report, you should know what the report says! Even more, identity theft is rampant and errors can also happen.

By law, you are allowed to obtain your credit report at least once per year. Obtain your FREE credit report at www.annualcreditreport.com.

Each credit reporting agency will attempt to sell you a credit score, but you are not obligated to do so!  Decline the offer and obtain your credit report from each of the three credit reporting agencies – Experian, TransUnion, and Equifax. You can print each report as well as save it to your computer.

Facts You Should Know

  • www.annualcreditreport.com
  • Obtain a credit report from each of the three credit reporting agencies – Experian, TransUnion, and Equifax
  • If married, obtain these three credit reports for each of you
  • Review carefully for accuracy

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