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Understanding Your Credit Score

By: Rhonda Patton

Do you know what your credit score is? It is an important piece of financial information that you need to know. A credit score is a three digit number that ranges from 350 – 850 and is used by creditors and lenders to determine your credit worthiness. The credit scoring system analyzes your credit report and assigns points. The resulting score is compared to millions of similar consumer profiles. Creditors and lenders use this score to decide what risk is involved in extending credit to you. It is also used to determine what interest rate you will get on loans and credit cards.

Credit scores are determined using a mathematical formula that analyzes data from your credit reports at the three main credit reporting agencies, TransUnion, Equifax, and Experian. There are several scoring systems, but the one most commonly used is called FICO. The FICO scoring system was developed by the Fair Isaacs Corporation in 1958 and is the model used by the other reporting agencies.

The score is based on the following:

  • Payment history. This includes how timely you were, how many times you were late, and how many collections, bankruptcies, etc you incurred. This accounts for 35% of your score.

  • Outstanding debt. You are rated on how many outstanding loans you have, how many credit cards you have, and if you are at the limit. Higher limits can reduce your credit score, so paying down credit cards will be necessary to get scores up. This accounts for 30% of your score.

  • Length of credit history. Lenders want to see that you have established credit and have made timely payments for a long enough period of time to show consistency. This accounts for 15% of your score.

  • Type of credit. People who have a mix of revolving (like credit cards) and installment credit (like mortgages) are seen as better risks. The assumption is that people with both of these types of credit experiences have better money management skills. This accounts for 10% of your score.

  • Frequency of credit applications. This is the most surprising to most when it comes to understanding how a credit score is determined. Believe it or not statistics have determined that people who apply for credit frequently are less likely to pay their bills. Checking your credit frequently and inquiries made by businesses looking to sell products to you are not included in this calculation which accounts for 10% of your score.
Now that you know what a credit score is and what comprises it, go look it up! It is only recently that consumers were allowed to view their credit scores. Previously, lenders were the only ones privy to this information. Additional changes to the Fair Credit Reporting Act (FCRA) now allow for consumers to obtain one free credit report annually from each of the three credit reporting agencies, so take advantage of the new laws. Find out what is weighing your score down and make the necessary improvements. Doing so will save you money.