Understanding your credit score
A credit score is a calculation that is
designed to give credit issuers an instant picture of how creditworthy an
individual is. Consumers with the highest scores are considered better credit
"risks" and therefore are more likely to be offered the most favorable terms on
a loan or credit card agreement.
In the past, few consumers paid
attention to their FICO scores. One reason was that credit scores mostly were
kept secret from consumers until early 2001. Before then, lenders were the only
ones with access to FICO scores. Fair, Isaac and Co., the firm behind the FICO
credit scoring method, now allows consumers to obtain their own credit scores.
They can be purchased, along with your credit report, from all three major
credit bureaus (Equifax, Experian, TransUnion) for prices varying from $10-$40.
Credit scores also may be purchased at www.myfico.com.
To understand just how important your score is, consider this one example: According to
myfico.com, a home buyer asking for a 30-year, fixed-rate mortgage of $150,000
who had a FICO score of 674 would be eligible for a 7.79 percent rate; a
consumer with a score one point higher (675) would be eligible for a 6.64
percent rate on the same mortgage and a significant cost savings.
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Your Credit Score Calculated
Information from your credit report—such
as your bill-paying history, the kinds of accounts you have, outstanding debts and the length of your credit history—is compiled and compared to the
information of other consumers with similar profiles. A certain number of points
is granted for each factor, depending on how much it pertains to a consumer's
creditworthiness. The end score will be a number between 300 and 850. Lenders
like to see scores above 700. Here are some tips to understand the percentage of
different factors that affect your credit score.
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Payment History (35 percent)
Your payment history accounts for the
largest portion of your credit score. It's extremely important to pay your bills
on time. Paying bills late, having accounts turned over to collectors or
declaring bankruptcy have strong, negative effects. Remember that your recent
payment history has a greater impact on your score, so it's especially important
to be punctual with your payments during the months preceding a new loan
application.
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Outstanding Debt (30 percent)
The amount you owe relative to your credit
limits can decrease your score as well. This includes what you owe on credit
card and loan balances.
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Credit History Length (15 percent)
Simply put, the lengthier your credit
history is, the higher your credit score will be. FICO scores take the age of
your oldest currently open account and the average age of all of your accounts
into consideration. Therefore, you may not want to close out old, unused
accounts, since this will shorten your credit history. You generally shouldn't
open new credit accounts just before you apply for a major loan. To do so would
lower the average age of your accounts.
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New Credit Applications (10 percent)
Try to resist that new, low-rate credit card. Every time you apply for credit, it's noted on your credit report.
If you're applying for credit frequently, lenders assume that you're eager to
get into debt.
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Your Credit Mix (10 percent)
You want to have a mix of revolving credit
(credit cards) and installment credit (such as auto loans). This will improve
your credit score; lenders will assume that you manage money well since
you have experience with different kinds of accounts. However, this does not
mean that you should have a large number of accounts. The more accounts you
have, the more credit you have available to you. Lenders assume that you may
overuse your credit if you have too much available to you.
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Know the Score
It's a good idea to access your score to confirm its
accuracy, especially before applying for credit. It's also a good idea to
purchase your score from all three credit bureaus. This is because each bureau
may have different information on you, depending on which companies have
contacted them about your accounts. Also, creditors will usually take the middle
of your three scores. Find out your middle score and then work to improve it.
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