Credit Score Mysteries Revealed

Credit scoring is a term that was not used until 2001. Before FICO (Fair Isaac Corporation) introduced it, humans were primarily the ones who assessed credit risk by analyzing data. A credit score is a black and white number assigned to an individual by a credit bureau used to determine a potential borrower’s credit worthiness and the likelihood and timeliness of loan repayment. It can impact whether or not you receive credit as well as other credit terms such as how high or low an interest rate you may be offered by lenders. Lenders consider several factors, including a credit score, when extending credit, but it can be said that credit scores are important benchmarks for lenders to examine when considering lending money.

The three credit reporting agencies, Equifax, Experian and TransUnion, determine a credit score based upon a formula developed by FICO. Each credit bureau uses a different term for their credit score. Equifax calls their score “Beacon;” Experian calls their score “FICO;” and Trans Union calls their score “Empirica."

Since lenders don’t usually report account activity to all three credit bureaus, a particular credit score may vary among them. Credit scores can range from 400 to 900 with the average around 700. According to the scoring model, as your score increases, your risk of default decreases.

If you ever wondered how your credit score is determined, it depends on five factors – payment history, amounts owed, length of credit history, taking on more debt and types of credit in use.

About 35% of a credit score may be based upon payment history. If you are in the habit of paying bills late or there is a history of delinquent payments listed on the credit report, including matters of public record such as bankruptcy or collection accounts, it impacts negatively on this factor.

Another 30% of a credit score may be based on amounts owed or other outstanding debt. A credit score can be get lower as the amount owed gets closer to the credit limit. A low balance on two credit cards may be better than a high balance on one credit card.

The length of credit history can account for approximately 15% of a credit score – the longer accounts have been open with a good payment record the better, especially if they are with one financial institution.

And here’s where you may want to “freeze” your credit score in time until after you;ve used your score to purchase a home. Approximately 10% of a credit score may be based upon how much new debt you apply for or use, even if you’ve recently applied for a number of new credit accounts and haven’t touched them.

The last 10% or so of a credit score may be based upon the types of credit currently in use by a consumer. A credit score is usually negatively impacted by loans from finance companies.

When a lender receives a credit score from the credit bureau, there will be reasons included that explain the score. If the lender rejects a request for credit and the credit score was part of the reason, the reasons help the lender explain why the score was not higher.

Credit score reasons are also useful in determining whether or not a credit report contains errors and/or how a consumer’s credit health might be improved. For more information about credit scoring, go to www.myfico.com.