How to Interpret Your Credit Scores

Some U.S. consumers are more confident about their ability to manage credit than they should be.

While 89 percent of consumers say they use credit responsibly, more than 25 percent of FICO scores —one of the most common credit scores used — are below 650, generally considered the lowest cutoff for getting good rates, according to a recent survey from Fair Isaac Corp., the Minneapolis-based developer of the FICO score.

"It's interesting that consumers, when asked, feel confident about it, but that's not really backed up by their actual scores," said Andy Jolls, vice president for, a division of Fair Isaac.

And while 65 percent of consumers strongly agree that they use credit responsibly, only 41 percent strongly agree they understand what goes into a credit score. Meanwhile, 43 percent say they're only concerned about their creditworthiness when they have a problem.

"The time to manage your credit is not when you're trying to put it to use," Jolls said. "When you're trying to actually buy a house and close in, let's say, three weeks, there's not a lot you can do about your credit score in that time. But if you were to look at it several months out, there are things you can do."

Within limits

What can you do to improve your score? Given that 35 percent of the FICO score is based on your payment history, paying your bills on time will, over time, improve your score.

Another 30 percent of the FICO is based on how much you owe, so keeping your balances low is crucial. FICO typically measures your credit utilization rate — the total dollars you've charged as a percentage of the total of all your credit limits — so you want to make sure you're not nearing those limits.

"Typically you want to pay down the debts on each card to below 35 percent of the limit," said Lucy Duni, director of consumer education at TransUnion's, which offers consumers its own version of a credit score.

Less important, but still accounting for about 10 percent to 15 percent each of your FICO are how long you've had credit and the number of inquiries, which occur when you apply for credit.

Various effects

Hard inquiries, generated when you apply for credit, can decrease your score, but many consumers won't notice a steep drop. (Soft inquiries, which don't affect your score, are those in which creditors check your report for marketing purposes or when you pull your own credit report.)

"For many people, one new hard inquiry won't affect their FICO score at all. For others, a hard inquiry will lower their scores by less than five points," says Craig Watts, a spokesman for Fair Isaac.

"Inquiries can have a more dramatic effect when the person has a very short credit history, has very few accounts, or triggers a lot of hard inquiries in a short time," he says. "People with six inquiries or more on their credit reports are eight times more likely to declare bankruptcy than are people with no inquiries on their reports."

The mix of credit you hold — such as student loans, credit-card debt and mortgages —can also affect your score. "Fair Isaac's studies show that people who can successfully manage multiple kinds of credit accounts are lower risks, everything else being equal, than people whose credit reports show less diverse experience," Watts said. Still, your account mix affects less than about 10 percent of the total score.

"To get a good FICO score, it isn't necessary to have one account of each type, and it isn't a good idea to open credit accounts you don't intend to use," he says. "People should focus instead on the really influential factors: paying every bill on time, keeping credit-card balances low and opening new accounts only when they are genuinely needed."

Also, don't forget the score models look at many moving parts. An action that raises one person's score could lower yours.

For example, applying for a new line of credit will temporarily reduce many people's credit scores. "Statistically, you are a riskier borrower when you open new accounts," Watts said. (Your score will rise again in a few months as you pay that new account on time, he noted.)

But a new credit card could improve the score of a borrower with just one type of credit, such as a student loan.

"When someone with a very limited credit profile opens a different type of credit...because they've expanded the type of credit, that change can in fact improve their FICO score," Watts said. "We don't recommend people open new accounts in hopes that this will raise their score, because it's relatively rare."

Moving your balances to lower-rate cards

What about the smart financial move of opening up a low-interest-rate card to move a balance there from a higher-rate card?

Almost always, "that's going to lower your score because you're opening new accounts more often than the average consumer is," Watts said. "The FICO score can't see the interest rates you're paying. It has no idea why you're opening new accounts. It can only see what the report shows and that is a more frequent pursuit of new credit than is typical."

Still, consumers with high credit scores can afford to pursue lower-interest-rate cards "because you know you can afford these small hits to your score," Watts said. With "good credit habits, your score will recover."

And, given that the new account increases your overall credit limit (as long as you don't close the old one), you could get a positive nudge to your credit utilization rate.

"In some cases, the person could be improving their score slightly by adding more available credit," he said. Still, "they could be hurting their score by opening new accounts in order to get at that available credit."

Copyright (c) 2006 MarketWatch, Inc.