Credit Score 

Credit scores are the rating system used by lending institutions to determine whether they are willing to lend you money.  They are very important to you as they not only dictate whether you are able to borrow but also at what rate you can borrow.  The better (higher) your credit score, the lower your interest rate and fees to borrow will be. 

Credit scores range from the 500’s to the 900’s.  The higher the score, the more “credit worthy” you are.  These credit scores are based on the information in your credit report.  A good score that will allow you to be credit worthy with lending institutions is 680+.  A score below 620 reduces your chances of getting a loan at the best rates.  If your credit score falls below 600, expect challenges in borrowing money.

What is a FICO Score? 

Your credit score is generally provided to a prospective lender by three major credit reporting agencies:  Equifax, Experian and Trans Union.  These three companies as well as all other credit reporting companies are called credit bureaus.  Credit bureau scores are often called “FICO scores” because most credit bureau scores used in the US are produced from software developed by Fair, Isaac and Company (FICO).  So when you see the term FICO score, think credit score.

How Credit Scoring Works

Your FICO score is calculated by a mathematical equation that evaluates many types of information that is on your credit report at that agency.  By comparing this information to the patterns in hundreds of thousands of past credit reports, the score identifies your level of future credit risk.  In order for a FICO score to be calculated on your credit report, the report must contain at least one account that has been open for six months or greater.  In addition, the report must contain at least one account that has been updated in the past six months.  This ensures that there is enough information – and enough recent information – in your report on which to base a score.

What a FICO Credit Score Considers

Listed below are the five main categories of information that FICO scores evaluate, along with their general level of importance.  Within these categories is a complete list of the information that goes into a FICO 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.

2.    Amounts Owed - How much is too much?
APPROXIMATELY 30% OF YOUR SCORE IS BASED ON THIS CATEGORY.

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.

3.    Length of Credit History – How established is yours?
APPROXIMATELY 15% OF YOUR SCORE IS BASED ON THIS CATEGORY.

In general, a longer credit history will increase your score.  However, even people who have not been using credit long may get high scores, depending on how the rest of the credit report looks.

4.    New Credit – Are you taking on more debt?
APPROXIMATELY 10% OF YOUR SCORE IS BASED ON THIS CATEGORY.

People tend to have more credit today and to shop for credit – via the Internet and other channels – more frequently than ever. FICO scores reflect this fact. However, research shows that opening several 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 certain “inquiries” to the credit reporting agencies, resulting from your requests for new credit. An inquiry is a request by a lender to get a copy of your credit report.

FICO scores do a good job of distinguishing between a search for many new credit accounts and rate shopping, which is generally not associated with higher risk.

5. Types of Credit in Use – Is it a “healthy” mix?
APPROXIMATELY 10% OF YOUR SCORE IS BASED ON THIS CATEGORY.

The score will consider your mix of credit cards, retail accounts, installment loans, finance company accounts and mortgage loans. It is not necessary to have one of each, and it is not a good idea to open credit accounts you don’t intend to use. The credit mix usually won’t be a key factor in determining your score – but it will be more important if your credit report does not have a lot of other information on which to base a score.

How a Score Breaks Down

These percentages are based on the importance of the five categories for the general population. For particular groups – for example, people who have not been using credit long – the importance of these categories may be somewhat different.

In Summary

Your FICO score is something that is very important to you. It determines the cost of money borrowed and how much you can borrow. It determines whether you are even able to make purchases on credit. Before you ignore a bill or respond to yet another credit card opportunity that comes through the mail realize that those decisions can influence your future borrowing power. A good credit rating should be valued and protected. There may come a day that you really need it.