Credit scores are an important fact of life: they dictate whether you can borrow funds, and what interest rates you'll be offered for credit you qualify for. But, how does your credit rating affect your life without you knowing — and should it scare you? (For more, find out What Credit Score Should You Have?)
Your credit rating, or FICO score, is based on information in your credit report. You probably know that your credit score comes into play when you apply for a credit card, loan or mortgage but it impacts your life in other significant ways:
TUTORIAL: Credit And Debt Management
When you apply for an insurance policy, your credit score and credit report do play a role in determining your risk, but it's one small part of a much larger scoring system. Ultimately, whether an insurer decides to extend coverage to you depends on your credit-based insurance score. Every insurer uses a different formula to arrive at the insurance score, but it is essentially a statistical analysis tool that calculates risk based on lifestyle, location, employment and many other factors. From that analysis, insurance premiums (or, what you pay for coverage) are determined.
Employers sometimes use credit reports when making hiring and promotion decisions, especially for positions that involve financial transactions. However, the Fair Credit Reporting Act (FCRA) mandates that employers obtain written consent from the employee or prospective employee before checking your credit rating. If the employer does pull your credit rating, he or she must provide you with written notice that it has been accessed. If the employer decides not to hire or promote a candidate based on information in the credit report, he or she is legally required to notify the candidate of the "adverse action," either verbally, electronically or in writing. The candidate then has the legal right to request a free copy of the credit report within 60 days. (To help you get a job, read Job Hunting: Higher Pay Vs. Better Benefits.)
If you've received mail telling you that you qualify for a specific credit card, personal loan, or mortgage then your credit rating has likely been scanned by the person sending you the offer. How does a company you've never done business with know so much about your finances?
The practice of "pre-approval screening" is perfectly legal and not at all uncommon. According to the Federal Trade Commission (FTC), you end up on the sender's list because they have identified a minimum credit score prospective customers must meet and had a consumer reporting company provide a list of customers who meet that criteria or they provided a prospect list to a consumer reporting agency and asked who on it matched certain criteria.
Though prescreened offers don't impact your credit score, you will see inquiries that were made and by whom, when you review your credit report. If you don't like the idea of a company snooping around in your credit, "opt out" of prescreen offers at optoutprescreen.com if you live in the U.S. (For more, see Pre-Qualified Vs. Pre-Approved - What's The Difference?)
The best way to ease fears about your credit rating is to educate yourself on how credit works. By law, you have the right to access a free copy of your credit report once every 12 months at annualcreditreport.com.
It's also important to understand what behaviors and events positively or negatively impact your credit. FICO scores are based on this simple formula:
While your credit rating can make or break your life, it isn't something to fear. When you understand how to use credit responsibly, you'll eventually earn a solid credit score and save yourself precious percentage points in interest payments. (For more tips on improving your credit score, see 5 Keys To Unlocking A Better Credit Score.)