|
|
|
A credit score is basically a statistical method of assessing your credit
worthiness. Credit scores are based on various factors including your
credit history,
amount of outstanding debt, and the type of credit you use. Negative information
such as late payments and bankruptcies is
also
used
to
calculate
your
credit
score. Credit scores
are used when applicatns apply for mortgages, auto loans, credit cards,
auto insurance, and homeowners insurance. The rate you receive is
directly
related
to your credit score. The higher the number, the better you look to lenders.
People
with
the
highest scores get the lowest interest rates.
Consumers' Rights
Not long ago, many Americans didn't even know this number existed because it
was a closely guarded secret in the lending industry. In fact, lenders were prohibited
from telling borrowers their credit score.
This changed though when consumers began finding out about the
score and demanding to see it. In an unprecedented move in 2000, online lender
e Loan offered to give consumers their scores for free, with information explaining
how the score is calculated and how they might improve it.
Public outcry on the possibility of people being denied credit based on bad information
in credit reports led to several pieces of legislation and a much more open
attitude about credit scores. Not only can consumers
today buy their score online from any number of sources, but they are now entitled
to one free credit report per year.
Key Factors of Your Score
Just what goes into the score? The model looks at more than 20 factors in 5
different
categories.
1. How you pay your bills (35% of score)
The most important factor is how you've paid your bills in the past, placing
the most emphasis on recent activity. Paying all your bills on time is good.
Paying them late on a consistent basis is of course very bad. Having accounts
that
were
sent
to collections is worse. Declaring bankruptcy is even worse.
2. Amount of money you owe and the amount of available credit (30% of score)
The second most important area is your outstanding debt -- how much money you
owe on credit cards, car loans, mortgages, home equity lines, etc. Also considered
is the total amount of credit you have available. If you have 10 credit cards
that each have $10,000 credit limits, that's $100,000 of available credit. Statistically,
people who have a lot of credit available tend to use it, which makes them a
less attractive credit risk.
Carrying a lot of credit card debt doesn't necessarily mean you'll have a lower
credit
score as long as you don't max out every card. As a general rule, you don't
want
to carry a balance of 50% or more of the available credit on each card. People
who
consistently
max
out
their
balances
are
perceived
as
riskier.
People
who
never use their credit don't have a track history. People with the highest scores
use credit sparingly and keep their balances low.
3. Length of credit history (15% of score)
The third factor is the length of your credit history. The longer you've had
credit, particularly if it's with the same credit issuers, the more points
you get.
4. Mix of credit (10% of score)
The best scores will have a mix of both revolving credit such as credit cards,
and installment credit, such as mortgages and car loans. Statistically,
consumers with a richer variety of experiences are better credit risks. They
know how to handle money.
5. New credit applications (10% of score)
The final category is your interest in new credit -- how many credit applications
you're filling out. Constantly applying for new credit can eventually hurt your
score.
The scoring model doesn't look at:
| |
• age
• race
•
job
• income
• education |
• marital status
•
if you've been turned down for credit
• length of time at your current address
• whether you own a home or rent
• time on job |
A lender may consider all these factors when deciding whether to approve a loan
application, but they aren't part of how a FICO score is calculated.
Credit Scores are Not Perfect
The major drawback to credit scoring is that it relies on information in your
credit report, which is quite likely to contain errors. That's why it's critical
that you check your credit reports annually or at the very least 3 to 6
months before planning to buy a house or car. This will give you sufficient
time to correct any errors before a lender pulls your score. |
|
|
