What is a credit score?
Credit scoring has been around since the 1950’s. Credit scores are based on data derived from an applicant’s credit history and payment patterns. This information is maintained on file with credit bureaus. The three major credit repositories are Equifax, Experian and TransUnion. Statistical models that assign points to factors indicative of repayment calculate credit scores. Each model weighs and measures hundreds of factors to arrive at a number indicating the likelihood of repayment. The resulting score is a snapshot that sums up the applicant’s past payment performance and current usage. Because a score is a composite of all applicant information, no single factor-like a bankruptcy or late payment-will be the sold cause of an unacceptable score.
How are Scoring Models Developed?
When developing a bureau score, the repository analyses credit data on millions of consumers to determine credit patters that forecast risk. To develop scoring models, analysts collect two categories of data:
1. Application and credit bureau information about the applicant at the time he/she first applies for credit.
2. Performance records of the individual.
Predictive factors are identified, and weighted values are assigned to each. The result of this analysis is the creation of scoring models. Models are constantly re-evaluated and modified as social and economic factors change.
What Data is Analyzed?
Scoring models do not consider race, gender, religion, marital status, income, nationality, address, employment, position or title, length of employment, sexual preference or interest rate being charged on a particular credit card. Scoring models do analyze all the credit information stored in the bureaus credit file.
The system calculates your credit behavior based on percentages in five general categories:
Payment history – 35%
Amounts owed – 30%
Length of credit history – 15%
New credit – 10%
Types of credit used – 10%
Payment History (35% of the scores weight): The fewer the late payments, judgments, etc. the higher the score. Recent late payments occurring within the past 24 months are more indicative of future default. A 30-day late today will have a greater impact on the score than a bankruptcy 5 years ago with clean credit since.
Amounts Owed (30% of the scores weight): Low balances on several cards are better than high balances on a few cards. Balances higher than 30% of the credit cards limit will have a significant impact on the score. Too many revolving accounts can also be detrimental.
Length of Credit History (15% of the scores weight ): Other factors that influence a credit score relate to the age of the accounts listed. For example, the longer accounts are open, the better the score. Opening new accounts and closing seasoned accounts will negatively impact the credit score.
New Credit Inquiries (10% of the scores weight): Looking for a new credit card can mean higher risk if, for example, several credit cards applied for within a short period of time and other existing accounts are “maxed out”, (outstanding balances are at their limit). Multiple Inquiries for Mortgages and Auto Loans within a 30 day period are counted as only ONE INQUIRY. Promotional or Employer inquires do not adversely impact the applicant’s score. Only authorized inquires by the applicant for the granting of credit can impact the credit score. Your score is not affected by personal inquiries.
Types of Credit Used (10% of the scores weight): Finance company accounts score lower than bank loans or department store credit lines.
What Improves an Applicant’s Score?
There is no magical formula to improve a credit score. This information should be taken as general guidelines, each individual is unique and their situation may vary because of extenuating circumstances. Scores will improve automatically as the applicant’s overall credit picture improves. This will take time; however, there are a few things to remember:
Pay down balances on revolving accounts to less than 50% of the available credit line.
Do NOT close accounts unless you have too many revolving accounts and and/or have little or no balance. Length of credit history accounts for 15% of your credit score. Older accounts are generally better, so be judicious when cloising old accounts and opening new ones. Closed accounts are not forgotten by the credit bureaus. Their history will remain on your credit record and any late payments or collections will still be calculated in your score.
Do NOT consolidate debt (close existing credit cards) into one or two revolving accounts. Consolidating debt to one card my very well backfire because is often ups your "utilization rate" a gauge of how much of your available credit you are using. That rate contributes 30% of your score! For example, having two $10,000 limit cards each with a $5,000 balance is better than having one card with a $10,000 limit and a $10,000 balance. The utilization rate in the first example is 50%, while in the second example, it is 100%!
Review all credit information including accounts high balance-to-limits.
If there are errors in the credit report, the applicant should write the repository advising them of the misinformation. The Fair Credit Reporting Act gives the repository five days to notify the creditor of a dispute and request an investigation. Within 30 days the creditor must report back to the repository regarding whether the disputed entry should be modified, deleted, or remain. If there is no response from the creditor within the 30 days, then the repository must remove the item from the credit file. If there is any change to the applicant’s credit file, the repository must notify the applicant within 5 days of the change.
Take Charge of Your Credit
What’s the score?
The FICO credit score reflects dozens of parameters in one’s financial history. For years, this number – named for developers, Fair, Isaac & Company – was a tightly guarded secret. Congress has now secured your right to know – take advantage of it!
Score 700 – 850 – smooth loan process; best interest rates
Score 550 – 699 – medium risk; higher interest rates
Score 300 – 549 – sorry, no loans or credit cards
Know Your Score
Are you counting on a new car, a new roof, new furniture? Before you talk financing, send for your credit report and FICO score. If there are errors or other surprises on your credit report, contact creditors to make corrections or negotiate settlements. Also, be sure to notify the credit bureau of your dispute.
Legitimate black marks on your credit won’t disappear quickly, (It takes seven years; ten for bankruptcy.) However, time and your diligence can turn things around, Lenders will give recent responsible activity due consideration.
In our credit-driven society, taking charge of your credit should be an on-going process. Your FICO score is a snapshot in time, not set in concrete. Review it each year for errors that may have crept in and to monitor your progress. You have the power to know it, raise it, and maintain it.
Pay all bills – and pay on time
Maintain 2-4 credit cards
Close unused credit or store cards
Keep balances well below the limit
Pay more than the minimums
Establish long-term credit history
Too many credit cards or zero cards
High non-mortgage debt
Frequent job or address changes
Charge Off’s* (bills marked uncollectible)
*A deal-killer: contact creditor, clear it up and clear it off!
The cost to order a credit report/score ranges from free to $12.50. Current law allows one free credit report per year from each agency. FICO scores are not included and can cost from up to $10. Go to annualcreditreport.com for your free annual report.
For more information, get the booklet Understanding your FICO Score at myfico.com.
Big Three Credit Bureaus:
Equifax Information Services, LLC: Phone:800.685.111 web: www.equifax.com
Experian: Phone: 1- 888.EXPERIAN Web: www.experian.com
TransUnionLLCConsumerDisclosure Center: Phone: 1- 800.888.4213 Web: www.transunion.com