| Your credit score, what it means, and
why it is important.
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A credit score, commonly known as
FICO scores, are used by creditors to determine how
good a credit risk you are. It has predictive value
for telling the lender how likely you are to repay a
loan or to make payments on time.
The credit score is calculated
using information in your credit reports. Usually
each person living in the United States who has a
Social Security number, whether a citizen or not,
will have three versions of credit reports to their
name. Equifax, Experian and Trans Union are the three
main credit bureaus who collect your credit
information and provide your credit report (also
known as credit profile) to your lenders/creditors.
How is credit score calculated?
Credit scoring is a method of evaluating an
applicants creditworthiness by assigning values to
such factors as income, existing debts, and credit
references, etc. It takes inputs from your credit
report and your credit application and generates a
score (number) based on statistical models.
Different lenders may use different methods for
calculating scores; therefore, scores differ from
lender to lender depending on the type of
financial service you are seeking.
The most popular credit score is FICO score.
Fair Isaac & Company developed a score, called
a FICO score, to estimate the likelihood that you
will repay the loan. FICO summarizes your credit
history into a single number. There are really
three FICO scores computed by data provided by
each of the three credit reporting agencies -
Experian, Trans Union and Equifax. FICO scores
range between 300 and 850. The classification for
bad credit varies from one credit extending
institution to another. Generally, the acceptable
score for first tier credit institutions is 660.
However, there are many credit extending
institutions that accept scores down to 560. Below
this you may have to seek help from bad credit
extending institutions.
Everyone with a credit record
also has a credit score. Different lenders and other
companies may use different scoring systems, so your
score (and the products or services you're offered
as a result) may vary significantly from one source
to another.
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Described below are the five
main categories of information on your credit
report which are used in the calculation of your
credit score, along with their general level of
importance. Within these categories is a complete
list of the information that goes into a FICO score.
Be aware that:
- A score takes into
consideration all these categories of information,
not just one or two. No one piece of information or
factor will determine your score.
- The importance of
any factor depends on the overall information in
your credit report. For some people, a given factor
may be more important than for someone else with a
different credit history. In addition, as the
information in your credit report changes, so does
the importance given any one factor in determining
your score. Because the details of your financial
situation are unique, and the exact formula used in
calculation of your credit score is kept secret, it
is not possible to predict what factors will bear
the most weight in your situation. Thus, it's
impossible to say exactly how important any single
factor is in determining your score - even the
levels of importance shown are for the general
population, and will be slightly different for
different credit profiles. What's important is the mix
of information, which varies from person to person,
and for any one person over time.
- Your score only
looks at information in your credit report. Lenders
look at many things when making a credit decision,
including your income and the kind of credit you are
applying for. However, your FICO score does not
reflect these facts, as it only evaluates your
credit report at the credit reporting agency.
- Your score considers both
positive and negative information in your credit
report. Late payments will lower your score, but
having a good record of making payments on time will
raise your score.
- Your score does
not consider your ethnic group, religion, gender,
marital status and nationality. These are, in fact,
prohibited from use in scoring by US law.
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The Five Things That Count
1) Payment History:
Approximately 35% of your score is based on
your Payment History.
The first thing any lender would
want to know is whether you have paid past credit
accounts on time. This is also one of the most
important factors in a credit score. However, late
payments are not an automatic
"score-killer." An overall good credit
picture can outweigh one or two instances of, say,
late credit card payments. By the same token, having
no late payments in your credit report
doesn't mean you will get a "perfect
score." Some 60-65% of credit reports show no
late payments at all - your payment history is
just one piece of information used in calculating
your score.
Your score takes into account:
- Payment information on
many types of accounts. These will include
credit cards (such as Visa, MasterCard, American
Express and Discover), retail accounts (credit from
stores where you do business, such as department
store credit cards), installment loans (loans where
you make regular payments, such as car loans),
finance company accounts and mortgage loans.
- Public record and
collection items - reports of events such as
bankruptcies, judgments, suits, liens, wage
attachments and collection items. These are
considered quite serious, although older items will
count less than more recent ones.
- Details on late or
missed payments and public record and collection
items - specifically, how late they were, how much
was owed, how recently they occurred and how many
there are. A 30-day late payment is not as risky
as a 90-day late payment, in and of itself. But
recent payments and frequency count too. A 30-day
late payment made just a month ago will count more
than a 90-day late payment from five years ago. Note
that closing an account on which you had previously
missed a payment does not make the late payment
disappear from your credit report.
- How many accounts show
no late payments. A good track record on most of
your credit accounts will increase your credit
score.
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2)
Amounts Owed:
About 30% of your score is based on
Amounts Owed.
Having credit accounts and owing
money on them does not mean you are a high-risk
borrower with a low score. However, owing a great
deal of money on many accounts can indicate that a
person is overextended, and is more likely to make
some payments late or not at all. Part of the
science of scoring is determining how much is too
much for a given credit profile.
Your score takes into account:
- The amount owed on all
accounts. Note that even if you pay off your
credit cards in full every month, your credit report
may show a balance on those cards. The total balance
on your last statement is generally the amount that
will show in your credit report.
- The amount owed on all
accounts, and on different types of accounts. In
addition to the overall amount you owe, the score
considers the amount you owe on specific types of
accounts, such as credit cards and installment
loans.
- Whether you are
showing a balance on certain types of accounts.
In some cases, having a very small balance without
missing a payment shows that you have managed credit
responsibly, and may be slightly better than no
balance at all. On the other hand, closing unused
credit accounts that show zero balances and that are
in good standing will not generally raise your
score.
- How many accounts have
balances. A large number can indicate higher
risk of over-extension.
- How much of the total
credit line is being used on credit cards and other
"revolving credit" accounts. Someone
closer to "maxing out" on many credit
cards may have trouble making payments in the
future.
- How much of
installment loan accounts is still owed, compared
with the original loan amounts. For example, if
you borrowed $10,000 to buy a car and you have paid
back $2,000, you owe (with interest) more than 80%
of the original loan. Paying down installment loans
is a good sign that you are able and willing to
manage and repay debt.
3) Length of Credit History:
About 15% of your score is based on Length of
Credit History.
In general, a longer credit
history will increase your score. However, even
people with short credit histories may get high
scores, depending on how the rest of the credit
report looks.
Your score takes into account:
- How long your credit
accounts have been established, in general. The
score considers both the age of your oldest account
and an average age of all your accounts.
- How long specific
credit accounts have been established.
- How long it has been
since you used certain accounts.
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4) Are You Taking on More
Credit:
About 10% of your score is based on New
Accounts.
People tend to have more credit
today and to shop for credit - via the Internet and
other channels - more frequently than ever. Fair,
Isaac scores reflect this fact. However, research
shows that opening several credit accounts in a
short period of time does represent greater risk -
especially for people who do not have a
long-established credit history. This also extends
to requests for credit, as indicated by
"inquiries" to the credit reporting
agencies - an inquiry is a request by a lender to
get a copy of your credit report.
The scores distinguish between searching for many
new credit accounts and rate shopping, which is
generally not associated with higher risk. In part,
this is handled by treating a grouping of inquiries
- which probably represents a search for the best
rate on a single loan - as though it was a single
inquiry.
Your score takes into account:
- How many new accounts
you have. The score looks at how many new
accounts there are by type of account (for example,
how many newly opened credit cards you have). It
also may look at how many of your accounts are new
accounts.
- How long it has been
since you opened a new account. Again, the score
looks at this by type of account.
- How long it has been
since you opened a new account. Again, the score
looks at this by type of account.
- How many recent
requests for credit you have made, as indicated by
inquiries to the credit reporting agencies. Note
that if you order your credit report from a credit
reporting agency — such as to check it for
accuracy, which is a good idea — the score does
not count this. This is considered a
"consumer-initiated inquiry," not an
indication that you are seeking new credit. Also,
the score does not count it when a lender requests
your credit report or score in order to make you a
"pre-approved" credit offer, or to review
your account with them, even though these inquiries
may show up on your credit report.
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Length of time since credit report inquiries were
made by lenders.
- Whether you have a
good recent credit history, following past payment
problems. Re-establishing credit and making
payments on time after a period of late payment
behavior will help to raise a score over time.
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5) Types of Credit in Use:
About 10% of your score is based on Types of
Credit in Use.
According to the information
provided by the Fair & Isaac, the creator of
FICO credit score, about 10% of your credit score
is based on:
- What kinds of credit
accounts you have, and how many of each. The
score is a complex formula that takes into account
both the types of account, their mix and the total
number of credit accounts you have under your name.
- Credit account types
include: credit cards, retail accounts,
installment loans, finance company accounts and
mortgage loans. In general, the effect of how many
accounts you have and their mix would vary with your
income and other factors. It is not recommended that
you open new accounts just to "diversify"
your credit profile. This part of the credit score
is more important if you do not have a lot of other
credit information on your file, as would happen for
example to young adults.
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How can you Get Your Credit Score?
Your scores, along with an explanation of how the
score was derived, are available online.
Click here if you don't know what your Credit Score is.
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