Credit Score 101

When it Comes to Your Credit Score You Should be in the Know.

It’s just a little three-digit number, but who knew it could have so much of an effect on your financial future!

Credit scores range from 300 (very low) to 800 (very high). If you’re credit score is low – meaning it’s below 620 – creditors will look upon you as a high credit risk or someone who is not worthy of credit. A low credit score will make it hard for you to obtain credit cards and loans, and when you do, it may cost you thousands of dollars in outrageous interest fees. Credit scores that exceed 720 are viewed as excellent by creditors. A high credit score suggests that you are low credit risk, which means your potential for repayment is high and you will likely be approved for loans and credit cards with the best interest rates and most flexible repayment plans. The bottom line is that a high credit score means that you can be trusted with credit.

So your credit score is the way by which lenders judge your repayment potential. The score is obtained by credit bureaus, the top 3 credit reporting agencies within the United States are Equifax, Experian, and TransUnion. All 3 credit reporting agencies use a universal mathematical scoring system, known as the FICO scoring system, to evaluate your credit-worthiness.

The FICO credit evaluation system

The FICO scoring system was named after the company who created it - the Fair Isaac Corporation. The company was founded by engineer Bill Fair, and mathematician Earl Isaac, in 1956. Their mathematical formula is still used to measure the credit worthiness of individuals.

The exact FICO credit evaluation formula is protected under trade secret law, but credit bureaus do make The 5 most influential factors to your credit score common public knowledge:

1. Repayment History 35%
2. Balances Owed 30%
3. Credit History Length 15%
4. Recent or New Credit 10%
5. Types of Credit 10%

With these 5 factors in mind, it’s obvious that we all have control over our credit scores. Take for example that 35% of your credit score evaluation is dependant on your repayment history. From this it’s obvious that if you pay your bills on time you will go a long way in making sure your credit score is high.

5 ways to protect your good credit score

Considering the above credit score influencing factors, you can protect your good credit score in the following ways:

1. If 35% of your credit score is based on your repayment behavior – Pay off the balances of your credit cards and loans in full every month and on time.
2. If 30% is affected by how much debt you have – Work to pay off any outstanding balances on your credit card or loans.
3. If 15% of your credit score depends on your credit history – Get your first loan or credit card and use it regularly. Stable credit history is important.
4. If 10% depends on new credit applied for – Be picky when it comes to what types of credit cards and loans you apply for.
5. If 10% weighs depends on your varied credit – Aim to diversify your credit –a mixture of credit cards, mortgages and auto loans is attractive to lenders.

Your credit score will affect you anytime you apply for the following services that pertain to credit:

• Personal or business loans
• Real estate loan or mortgage
• Automobile loan
• Educational loan
• Credit card
• Rental property
• Utility – such as hydro or electric service or telephone/Internet

Additional FICO facts

From this explanation it seems like FICO’s credit scoring system is cold and emotionless, but how can that be when our finances are weighed down by so many personal qualities. For instance your credit score doesn’t mention that you had to declare bankruptcy due to a sudden illness or job loss. It also doesn’t take age into account, so young adults often score low due to having zero credit history (past credit cards or loans), when they are just trying to act responsibly. Your credit score doesn’t take into account the following factors:

• Race
• Gender
• Age
• Employment history

Basically your credit report is based on non-discriminatory information that includes the following:

• Credit repayment behavior – Do you make frequent late payments?
• Do you go over-limit – Do you maxed out credit cards regularly?
• Have you declared bankruptcy or defaulted on a loan?

All 3 of these factors will negatively influence your credit score – meaning they will result in points taken away.

The Federal Trade Commission (FTC) created the Fair and Accurate Credit Transitions Act (FACTA) in 2003 in order to grant every U.S. citizen the right to obtain a free credit report from all 3 national credit bureaus. You should know the following when it comes to obtaining your free annual credit report:

• Free credit reports can be obtained once every 12 months.
• The information included in your credit report is the basis for your credit score
• Errors on your credit report will lower your over all credit score.
• If you believe there is an error on your credit report it is your responsibility to contact the 3 credit bureaus to have it removed.

More useful credit score links:

For more information about your right to a free annual credit report, visit the Federal Trade Commission at FTC.gov. For more information about FICO scores and calculations, visit MyFico.com.