When was the last time you took a good, long look at your credit report? It’s probably not as good as it could be. You have debt. Sure, you could go what you think is the easy route and just shift the debt to a new, zero-interest card, hoping things will turn out for the best. Meantime, your credit score will stagnate in the long run because you’re not addressing the real sources of your debt problems.
What is a credit score?
When you open a line of credit with an institution, your creditor begins to send information to the three credit-reporting agencies: Equifax, Experian and TransUnion. Each of these bureaus accumulates this information and presents it as your credit report. Most items on your credit report will only be present for seven years. Some, including certain kinds of bankruptcies, can stay on your report for ten years.
In more recent years, lenders have realized that it would be easier for them to have your credit classified on a numerical scale instead of reading all the details of your report and deciding for themselves. Thus, the credit score was born. The most common credit score is the Fair Isaac Company (FICO) score. The numbers range from 300-850, with higher numbers indicating that you are more responsible with debt.
What goes into a credit score?
There is a specific rubric that goes into the formation of your FICO score. It involves:
- Length of your credit history
- Payment history
- Number of new accounts
- Debt to available credit ratio
- Negative items (e.g. late payments, charge offs, foreclosures)
Based on this information, each of the three reporting agencies assigns you a credit score.
What’s wrong with this?
The fact is, your FICO score does not tell a full story of your financial dealings. If you make a lot of money, if you have a large savings account, if you have worked at the same company for 30 years–none of these things factors into your score. This leads some experts to claim that your credit score is not and should not be the only thing lenders look at when determining your creditworthiness.
Personal finance guru Dave Ramsey argues that the way credit scores are determined encourages people to mismanage their debt as a means to improve their FICO scores. For example, people might open new credit card accounts and transferring debts to them. This will improve their ratio of debt to available credit, and their scores will go up. But, Ramsey says, this does nothing to address the debt they have. He calls the FICO score an “I love debt” score to indicate what he feels is the true nature of the measurement.
Ramsey suggests that people not worry about what their scores look like, and focus on their debt instead. He recommends that people follow his “debt snowball” approach. In this technique, consumers should start putting as much as they can toward the smallest debt they have (e.g. pay off a $500 debt before working on a $2,000 one). Once the smaller debt is paid off, they can move to the next smallest one, and so on. Ramsey argues that this approach helps people to naturally consolidate their debts, while also helping them to eliminate the debt once and for all.
Having a good credit score is important. But it is even more important to eliminate debt and find ways to avoid using credit as much as possible. If you work to pay off your debt, you will have less need of your credit score in the first place.
Nicole writes for the credit industry. She enjoys teaching others new ways to better manage their finances. She trusts BestCreditRepairCompanys.com as a good reliable source for credit repair info.