Credit card companies, lenders, landlords and even prospective employers use credit scores to determine an individual’s level of financial responsibility. Credit scores are supposed to be snapshots of a person’s credit history. They are determined by Fair, Isaac & Co., which is commonly referred to as FICO. When individuals have low scores, their credit applications are usually denied. In some cases, a score that is low but not too low for approval will result in a high interest rate. Many lenders use a person’s credit score to set the loan cost. It is important for everyone to understand how credit scores are calculated.
Factors Affecting Credit Scores
The method FICO uses to compute scores is very complex. However, several factors represent a percentage of the overall score. Here is a summary of the factors and their corresponding percentages:
– Payment history comprises 35 percent of the total score. This includes data from monthly bills, collection accounts and past bankruptcies. In today’s world, a 30-day delinquency is worse than a bankruptcy filed five years ago.
– Outstanding debts make up 30 percent of the score. If the total amount of debts is close to the total amount of available credit, the result is usually a lower score. Having a high balance on one credit card is worse than having low balances on two cards.
– Credit history length comprises 15 percent of the score. Accounts that have been open for a long time are better for a score than new accounts.
– The types of credit accounts make up 10 percent of the score. Loans obtained from finance companies usually result in a lower score.
– Recent inquiries on a credit history account make up 10 percent of the score. People who have recently applied for new loans or credit accounts may see negative effects on their scores.
Some credit companies are more concerned about specific parts of a person’s credit history. For example, one company may put a heavy emphasis on payment history. However, another company may be more concerned about the types of accounts open.
One of the biggest questions people have about their credit scores is which numbers are good and which ones are bad. As a rule, scores range between 300 and 900. The average score is about 750. As peoples’ scores increase from this number, their default risk decreases. Research has shown consistent connections between high default rates and low scores.
People who have scores below the average number of 750 may have difficulty convincing creditors to offer affordable loan rates. However, it is important to compare rates. Not all lenders gather data from the same reporting bureaus. There are three main bureaus, and each one may have different information than another. For example, Experian may include information about a sizable collection account that another bureau may not. This may result in a lower score from Experian. If one lender uses Experian and another uses Equifax, the lender using Equifax would probably offer the best deal in such a scenario.
Although credit scores are usually different from one bureau to the next, it is rare to find large gaps. For example, the average person would see a set of scores such as 750, 745 and 760. It would be rare to see a set of scores that include 750, 760 and 505. However, inaccuracies can bring such rarities into reality. This is one of the reasons why it is important to monitor credit scores. Everyone is entitled to one free annual report copy, so be sure to take advantage of this opportunity. For a fee, consumers can view their credit scores online. Ask an agent about approved sites for obtaining credit scores. Not all sites are reliable, and some are only out to collect personal data.
Not all people are happy when they see their scores. If it is necessary to raise them, follow these suggestions:
– Keep all payments current, and make up any missed payments.
– Pay all obligations on time.
– Keep low balances on credit cards and any revolving lines of credit.
– Pay off debt constantly instead of letting it pile up or transferring it to a new account.