Understanding Your Credit Score
This rating system is meant to develop a snapshot of the risk you currently represent to a lender. Several parameters in your credit file, including length of credit history, number of open accounts, loans, mortgages, public records, and others are formulated to produce a three-digit score between about 300 and 850.
Usually a lender will use a combination of your credit score with other factors when determining your risk. They all claim to have the same objective, to determine the borrower’s potential risk. Regardless of whether the score was generated by FICO® or a system based on FICO® parameters, they all yield an industry standard three-digit score. This score places the borrower in one of three main categories (we named the third one ourselves.)
Prime, Sub-Prime and Shafted
- Prime: If your credit score is above 725, you are considered “prime” and, in a normal economy, you will have no problem getting low interest rates on home loans, car loans, credit cards and any other credit extensions you might need.
- Sub-Prime: In this new economy, if your credit score is below about 675 to 700, you are considered “sub prime”. As such you will be unable to qualify for most mortgage loans and you will be charged higher interest rates on car loans, credit cards and other credit.
- Shafted: If your credit score is below about 650, you are “shafted”. At least that is how banks, lending institutions and any other credit issuers will perceive you. You can still get credit cards but you’re going to be hit with security deposits, application fees, monthly fees, annual fees, membership fees, “risk assessment” fees, underwriting fees, origination fees and the list just goes on and on. In addition to that, your interest rates will never dip below 15% and will more likely be in the 16% to 29% range. In this economy you can forget about getting approved by any bank or lending institution for a home mortgage loan. The majority of new and used car loans will still be available, but you won’t qualify for anything under about 15% interest.
Below 650 is no place to be. You will pay tens or perhaps even hundreds of thousands of dollars more in higher interest and unnecessary fees on every loan and credit card you get during your lifetime if you don’t take action and do something to improve it. You’ll even pay more for insurance and a very low score can even prevent you from getting a job with many companies. If you’re in this catagory Click Here.
How are credit scores calculated?
The methods of calculating your credit score may differ slightly depending on the credit bureau. When obtaining your score from one of the Credit Bureaus it is important to understand that your score does not come directly from FICO®. It is adapted to each bureau and is given its own name: Equifax uses “Beacon”, Trans Union uses “Empirica”, and Experian uses “Experian/Fair Isaac.” These scores are also referred to as your “Bureau Scores.”
Since your score is derived from your bureau data, it will change every time your reports change. However your score is calculated, it will always take into consideration many categories of information. No one piece of information or factor determines your score. As the information in your credit report changes, the importance of one or several factors may change in your score. Lenders look at many things when making a credit decision, including your income and the kind of credit you are applying for. However, your credit score does not reflect these facts as it only evaluates the information retained by the credit reporting agency.
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What factors affect your credit score?
There are five factors which are used in credit scoring calculations that determine your overall credit score.
- Previous Credit Performance (Payment History) (35%) - A lender wants to know what your payment history is like. Have you paid everything on time, are you late on anything now, and so on. Your payment history is just one piece of information used in calculating your score, although it can be the very important.
- Current Level of Indebtedness (Amount Owed) (30%) - How much is too much? Can the borrower pay me and still afford to pay his other bills? Not necessarily. Having available credit can actually help your ratio of debt to available credit. These are the types of questions that most borrowers want to know and the answers are almost as important as your previous credit history.
- Amount of Time Credit Has Been In Use (Length of Credit) (15%) - Generally speaking, the longer the credit history the better your score. However, this factor only makes up 15% of your total score so even young people, students or others with short histories can still score high overall as long as the other factors show good. If you are new to credit than there is little you can do to improve this part of your score. Open an account and be patient.
- Pursuit of New Credit (10%) - Credit is much more popular today. Just look at the number of credit card offers you get via the Internet and in the mail. Consumers can now shop for credit and find the best terms to meet their needs. Each time someone runs a credit check on you, it creates an inquiry. Fair Isaac has changed some of its calculations to account for these new trends. Specifically, they treat a group of inquiries - which probably represents a search for the best rate on a single loan - as though it was a single inquiry (note: this only applies to auto or mortgage loan inquiries.) For example, auto loan inquires that are within 14 days of each other only count as one inquiry.
- Types of Credit Experience (10%) - A healthy mix of different types of credit, installment loans, retail accounts, credit cards, and mortgage. This score is not normally a key factor in determining your score but it can help a close score. Its not a good idea to try and open different types of accounts just to try and make this factor better. It will likely reduce your score in other areas. You should never open accounts you don’t intend to use anyway.
What type of accounts you have, and how many, can make a big difference. The optimal ratio of installment versus revolving accounts depends on your profile and differs from person to person. One factor that seems to have significant influence is your percent of open installment loans. Too many can lower this portion of your score.
Improving Your Credit Score
Now that you know how your score is calculated, you can begin making changes to your current financial planning. The best things you can do are simple.
