The Story Behind Your Credit Score


Obtaining credit can be a real puzzle, yet your score will impact the interest rates lenders offer and whether you will be approved for a loan.

Even if you are not applying for a loan, your credit score will impact what you pay for insurance, whether you will need to make a deposit for services like utilities, internet, satellite, cell phones and so forth. Apartment complexes and employers also frequently use your credit score when making a decision about your application.

WHAT IS THE DIFFERENCE BETWEEN A CREDIT SCORE AND A CREDIT REPORT?

A credit report is the actual record of how you have paid your bills. The credit record is established as your accounts are reported to the three credit bureaus — Equifax, TransUnion and Experian. Typical accounts include mortgages, car loans, student loans, credit cards and any other bank loans. What is not included are utility bills, cell phone bills, bank accounts etc. These are only reported to the bureaus if they are late or not paid. So when you move and don’t pay the last electric bill or water bill it winds up on your report as a collection and stays there for 7 years after it is paid in full. Generally late payments are reported for 7 years. Foreclosures and bankruptcies can be reported for up to 10 years.

There are a number of credit score companies but the one that carries the most weight with lenders is Fair Isaac Corporation, creator of the FICO Score. They use a proprietary formula that measures the level of risk, based on information in your report. This risk is represented by a score between 300 and 850. The higher the score, the more likely you are to pay your bills on time, the better terms banks are willing to offer. Banks, lenders, utilities, insurance companies, employers and others use the credit score to evaluate your character and make judgments about what kind of business they want to offer you.

WHAT’S IN YOUR CREDIT SCORE?

Each company establishes credit scores using a different formula, however, the principles and factors are similar. Here is how FICO comes up with your score.

Payment history is typically around 35% of the score. This measures whether or not you pay your bills on time. Recent late payments will count more than late payments that are several years old. A single late payment can impact your score for at least 7 years.

Utilization ratio. Simply put this is the amount of debt you have divided by the amount of debt you have used. This factor can count for as much as 30% of the credit score. If you have a credit card with a $10,000 credit limit and you have a balance on that card of $9,000 then you have a 90% utilization ratio. For purposes of your credit score the lower the ratio the better.

Understanding your credit score and what factors the algorithms consider will help you maintain the highest score possible.

Length of credit history comes in at around 15%. This figure considers how long your credit has been established. This is important when deciding whether to close a credit card or not. If it is a card you have had for years or even decades then it is best to keep it open, even if you only use it occasionally. Know that if you put the card in a drawer and never use it, the bank will close it after a period of time.New credit can be scored as high as 10% of your score. If you have not had any new credit recently, opening a new account can actually raise your score by a few points. Too many new accounts will hurt your score.Type of Credit and Inquiries are other factors in the credit score calculations. Type of credit evaluates whether you have loans or lines of credit. It is best to have a mix between the two. Credit inquiries looks at recent applications and attempts to access credit. Credit inquiries will remain on your report for two years. When banks view your report for the purpose of extending an offer of credit to you, this does not impact your score, only active applications.Understanding your credit score and what factors the algorithms consider will help you maintain the highest score possible. While you will not gain an 800 credit score with high levels of debt, maintaining on time payments and other factors can allow you to maintain a decent score, even with high debt. This will be important if you want to consolidate your debt to lower payments. The better your credit score is, the more options you will have.

HOW A FICO SCORE BREAKS DOWN