What is a credit score?
Your credit score is a three-digit number used to determine the probability that you will pay your debts and measures the risk of giving you credit. The number is generated by a mathematical formula based on the information in your credit report. Scores generally range from 300 to 850 and the higher your score, the better. The credit score is not part of your credit history. It represents your credit risk at the particular moment in which the score was accessed. This means that your credit score changes and can increase or decrease over time.
There are three credit bureaus from which you can obtain your credit score: Experian, TransUnion and Equifax. The most commonly used credit scoring model uses software from Fair Isaac Corporation and it is called the FICO score. Each credit bureau uses FICO software in order to generate a score based on the information that bureau has. As a result your score can be different depending on which credit bureau report you are viewing. There are other scoring models such as Vantage (which Experian has used since early 2009), NextGen and Community Empower but are less commonly used. While there is no such thing as a free credit score, you can obtain a free copy of your credit report every twelve months at www.annualcreditreport.com.
Your credit score can mean the difference between higher costs to borrow (or interest rates), employment and insurance premiums. Lenders use your score to determine whether or not you will be approved for credit, your interest rates and credit limits. Some employers and insurance companies use your score to determine your past level of financial responsibility as an indicator of reliability and risk.
What goes into the credit score?
• Payment history makes up about 35% of the score and is the most important factor. For credit scoring purposes, past payment history predicts how you might pay in the future.
• Debt balances and available credit represents 30% of the score. Current loan balances are compared to their original balances and revolving balances are compared to their credit limits to indicate whether or not you are overextended.
• The length of your history comprises 15% of the score. It tracks the length of time accounts have been open and reported to your credit report. The longer the history (assuming the history is good) the better.
• The types of credit you have generate 10% of the credit score. Typically a mix of revolving, installment, and secured and unsecured debts yields a higher score.
• The last 10% of the credit score tracks how recently and how frequently you apply for new credit. Generally the less often, the better.
Factors such as race, religion, sex, age, employment situation, income, education, housing situation, marital status, recent credit denial and family support obligations do not impact your credit score. However, a lender can use some of these factors (subject to federal and state law) along with your credit score in making lending decisions.
Managing your credit score is simple.
• Pay your bills on time. Payments that at least 30 days late are reported to the credit bureau and hurt your credit score.
• Use credit sparingly. Keep your balances on credit cards and other revolving debt low. Pay off loans as quickly as you can.
• Apply for credit only as needed. Unless you are shopping for auto loans or mortgages, multiple inquiries by lenders to your credit report can reduce your score.
• Avoid closing unused accounts. The available credit helps your score.
• Check your reports at least once per year. Inaccurate information can impact your score and you can only correct inaccurate information if you know it is there.
Improving your credit score is much more difficult than destroying it so start managing your score today. Invest in your future by purchasing your credit report and credit score. Be smart about borrowing and your use of credit wisely. With the impact that your credit score can have on your ability to borrow, career opportunities, insurance premiums, etc., it should be something that you keep close watch over.
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