Credit scores can have a huge impact on your financial affairs, housing options, career, even your insurance premiums. Although the specific formula credit rating agencies use is a trade secret, you should understand the basic components and how you can achieve the best score possible.
Fair Issac developed the primary scoring model in use, called the FICO score. FICO scores range from 300 to 850. Most lenders look for scores above 620, and higher scores are considered better credit risks. Each consumer credit reporting agency: TransUnion, Experian and Equifax applies the FICO model differently, so scores can vary. In an attempt to address these variances, a new scoring system launched in March of 2006. This model, known as the VantageScore, has not become the industry standard. However, consumers should be aware of its existence – particularly since the scores can range from 300 to 990. An outstanding score of 850 on FICO, would mean only “B” level credit with VantageScore.
Consumers also need to be aware that some companies develop their own in-house scoring models. Some estimates place the number of scoring models in use at over 1,000.
Regardless of which model is used, there are a few fundamental components that make up a score:
Payment history. “Past behavior is the best predictor of future behavior.” Most estimates suggest that up to 35% of your score is based whether you pay your bills on time. Also included in this calculation is the number of bills you have let fall delinquent, how long they were left unpaid and whether you have court judgments or bankruptcies tied to these bills. Recent late payments usually weigh more heavily that mistakes, but negative information can remain on your reports for up to seven years.
On the positive side, your credit score will benefit if you have accounts with “never late” or “paid as agreed” notations. Unfortunately, many creditors are diligent about reporting negative information but much less diligent about reporting positives.
How much you currently owe is usually just under a 1/3 of your score. This is intuitive. If you already have a large amount of loans outstanding, credits may be concerned that taking on more debt will overextend you. Often, new lenders look at the ratio of available credit to credit in use.
The final third of your score is usually calculated from the length of your credit history (longer is better), how much new credit has been added in recent months and the types of credit you are using. Secured loans like mortgages and auto loans are usually viewed more positively than unsecured debt like credit cards. Some consumers wonder if inquiries from insurance companies, credit card companies or potential employers will hurt their scores. The answer is generally no. Inquiries of this type only impact your scores when you choose to act on them in a way that will add to your debt load – for example, if you choose to apply for the credit card you were offered in a recent mailer.
Another item that doesn’t appear in your credit calculations is financial counseling. The circumstances that may drive you to consider
credit repair counseling. may be reflected in your scores, but you neither gain nor lose points by seeking this type of help. The good news is, a good credit counselor can help you address financial issues, pay off bills and in the end your credit score…and other aspects of your finances will benefit.
