Understanding Your Credit Score

Credit Score defined:  A number that helps lenders determine creditworthiness of a borrower.

Background on Credit Scores: There have been multiple algorithms developed that determine an individual’s credit score. The most common score used by lenders to determine creditworthiness and interest rates is the FICO Score or more appropriately a version of the FICO score (there are multiple FICO scores). The FICO Score was developed by the Fair Isaac Corporation in 1989.  MyFico.com makes the claim that a FICO score is used in 90% of lending decisions.

The second most commonly used score is the Vantage Score. Credit Karma, a reputable credit resource website that uses the Vantage Score, states that over 2000 lenders use the Vantage Score to determine credit worthiness. Most of the online free credit scores come from the Vantage Score formula. While for the most part this score is educational (in that most lenders use the FICO Score) it is still accurate and close to the FICO Score. The information gained from the Vantage Score most of the time will provide the information needed to improve an individual’s score.

How the FICO Score is Determined

The primary FICO score is on a scale of 300 to 850. It is has been determined that a score of 580 or lower is “poor score”, 580-669 is a “fair score”, 670-739 is a “good score”, 740-799 is a “very good score” and 800+ is an “exceptional score”.

 

The Fico Score is determined by 5 factors. The factors and percentage weight of each factor is as follows: 30% Amounts Owed, 35% Payment History, 10% New Credit, 15% Length of Credit History, 10% Credit Mix. The three credit bureaus Experian, Equifax, and Transunion provide the information that FICO uses in each factor to compute the score.

30% Amounts Owed:

This refers to the amount of credit an individual has used compared to how much available credit that they could use. Using credit each month for purchases will not necessarily a make a credit score go down in fact utilizing credit each month can potentially improve the score whereas not using any credit will not cause the score to be improved.

The closer that the amount of credit used gets to the amount of credit available the more likely that a score can go down. This is because it indicates that individual could have a high risk of over extending themselves and unable to pay back the borrowed amounts when they are due.

Fico scores pay attention to the amounts owed on different forms of credit and treat them differently.

Keys to Success: Pay off credit cards fully each month (if you have only a small amount of available credit it may benefit you to pay off your card balance more frequently than to just once during a billing period). Pay installment loan payments on time with the appropriate amount each month.

35% Payment History:

This is the heaviest weighted factor in computing an individual’s credit score. In general this factor is looking to see if an individual has made their credit payments on time. According to myfico.com if someone misses one or two payments but has a good history it most likely won’t hurt their credit score much at all. However, missing many payments can have a strong negative impact on one’s score.

All forms of credit accounts are considered in this factor. Fico also considers public records and collection items. Myfico.com states that negative factors include bankruptcies, lawsuits and wage attachments. Myfico continues with the details of late payments and collection items are considered such as how late they were, how much was owed, how recently they occurred, how many there are.

Keys to Success: Create a budget plan that ensures you are able to pay credit cards in full each month, afford monthly installment plans, and includes an emergency fund so that unexpected bills such as an Emergency room visit or replacing a washer doesn’t cause you to a bill sent to collections.

10% New Credit:

This factor focuses primarily on two items. The first is the age of an individuals and how much credit accounts have been opened in recent history. Adding a new credit card account has the effect of lowering the age of an individual’s credit which can potentially slightly lower their credit score. Likewise if an individual opens multiple accounts in a short span of time it can have a negative impact on a credit score because of the possibility of that individual being a higher risk – especially in instances when that individual does not have a long credit history.

The second item is inquiries. The FICO score only considers inquiries in the last 12 months even though most inquiries will stay on an individual’s credit report for 2 years.  With the fico score inquiries have a small if any impact. The score allows for individual’s to interest rate shop without being penalized by the inquiries.

Keys to success: Avoid opening numerous accounts rapidly. Only open a new credit account when needed.

15% Length of Credit History:

This factor improves as length of time an individual has credit. It is possible to a high FICO score without having a great score in this factor.

Myfico.com describes three items that are taken into account in this factor: “1) How long your credit accounts have been open, including the age of your oldest account, the age of your newest account, and average age of all your accounts. 2) How long specific credit accounts have been open. 3)How long it has been since the account has been used.”

Key to success: If you don’t have a credit score open a secured credit card, or find someone to cosign with you. Be slow to cancel a card that has been open for a long time even if it has been a source of debt. It is okay to not use it anymore, but it may not be wise to close it you are looking to building your score.

10% Credit Mix:

This factor considers the different forms of credit accounts that an individual has opened. This factor does not play a significant role in determine the FICO credit score. It is important to not go out and open a credit account unless it is actually needed. This factor considers whether an individual has experience in paying back different forms of credit accounts on time such as credit cards or installment loans.

Key to Success: Manage the accounts that you do have responsibly. If you have no credit accounts as mentioned above start with a secure credit card to begin to build credit.

Limits of the FICO Credit Score:

It is important to note that the information above is to be used as general guidelines. Every individual’s FICO Score calculation will be slightly different based of the individual’s experience with credit utilization and the fact that every individual has a unique credit history. Secondly, FICO has made multiple credit scores. Different lenders use different scores for different forms of credit. For example FICO has created a formula for a fico score specifically for mortgage lending that mortgage lenders tend to use. The same could be said of credit card lenders and car loan lenders.

How to Access my FICO Score?

It is extremely difficult to access a FICO score for free without taking a credit card with a company that offers a free score as benefit. Discover happens to be the only company we have discovered at this point that seems to offer one FICO score for free based off the Experian Credit Report. You can also access the Vantage Scores based of Equifax and Transunion credit reports by creating a free account with creditkarma.com. The Vantage Scores provide by Credit Karma and the FICO Score from Discover will provide valuable insight, and will help you improve your score without paying for access to other FICO scores.

To learn more about your credit score through reliable online resources we suggest visiting www.myfico.com, creditkarma.com, and yourvantagescore.com.

 

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