Your Credit Score-Now you Know
by Ellise Walsh

Many consumers are surprised to be turned down for loan requests because they do not fully understand how their credit score is calculated. They may believe their credit score is good simply because they have never had a bankruptcy or because they do not have a long credit history. The truth of the matter is that while bankruptcies are certainly a factor in determining a consumer’s credit score, there are also many other elements taken into consideration. Additionally, a short credit history does not necessarily work in a consumer’s favor. A consumer must have at least 6 months of credit history in order to even have a credit history at all.

Lenders use credit score reports to gather an idea of how much risk a consumer presents to the funds they ask to borrow. The lender wants to know whether the borrower will pay back the money and if the payments will arrive on time. The only way a lender can ascertain this is to take a look at how a loan applicant has handled credit in the past.

Credit reporting bureaus, such as Experian, use software to calculate consumer credit scores. While each software version does vary slightly in what is considered and how much weight is given to each measure, for the most part, they are very similar. Some of the differences might include income and length of steady employment.

The following factors are primarily used to calculate a credit score:

Timeliness of payments - Late payments, past due notices and collection attempts on overdue payments are taken into consideration as well as bankruptcies. This credit score standard contributes approximately 35% towards the overall credit score.

Number of accounts and debt make-up - Debts are either revolving or installment. Mortgages and automobile loans are examples of installment debt, where the original amount of the loan is paid off in regular payments. Revolving debt refers to a line of credit issued to a consumer, such as a credit card. Credit score agencies take into consideration what kinds of debt the consumer owes and how many accounts they have. This factor contributes about 10% towards the overall FICO credit score.

Age of credit history - How long has it been since the consumer’s first credit account (installment or revolving) was established? A shorter credit history is not better, even if the payments have been on time. About 15% of the credit score is derived from this category.

Recent loans and credit report inquiries - Any new loans or charge accounts that have been opened and any recent credit applications during the last twelve months will be considered. The number of credit applications is revealed in the frequency of credit report inquiries. Even if the consumer did not finalize the loan or credit card, the inquiry can still lower their credit score because high numbers of applications are considered to be a high risk indicator.

This is why it is imperative not to overuse offers for free credit reports. While they are beneficial to consumers who want to make sure there are no errors on their credit reports, they should be used with caution. 10% of the credit score is determined by recent loans and credit report inquiries.

Credit Card and Loan Balances - The balance remaining on both installment loans and revolving accounts will be taken into consideration. Of interest will be whether the consumer carries low balances or has maxed out the credit line on their charge cards. 30% of the credit score comes from this factor.

What is a good credit score?

Credit score range from about 300 to 900 points. In most cases, higher scores are better, although there are some instances when a very low score would not be an advantage. A low credit score may indicate there is very little credit history for an individual, which will therefore make it difficult for a lender to ascertain whether or not there is any credit risk.

A credit rating of 660 appears to be the magic number that separates low risk and high risk. Individuals with a credit score below 660 are deemed to be a higher risk; those with a credit score above 660 will qualify a borrower for better interest rates. Consumers with a credit score between 600 and 660 may well be able to still obtain a loan, however they will face much higher interest rates. The difference between points on a credit score can mean as much as a difference of 4 or 5 interest rate points. Calculated over the life of a long-term loan, such as a mortgage, this can amount to a significant amount of money in interest.

On average, the largest percentage of consumers fall into the 750-799 range.

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