What Is a Credit Score?
A credit score is a number that is calculated based on your credit history to give lenders a simpler “lend/don't lend” answer for people who are applying for credit or loans. This number helps the lender identify the level of risk they may be taking if they lend to someone. While the same end result can come through reviewing the actual credit report (which lenders usually do), the credit score is quicker and less subjective. The system awards points based on information in the credit report, and the resulting score is compared to that of other consumers with similar profiles. With this information, lenders can predict how likely someone is to repay a loan and make payments on time. It's the credit score that makes it possible to get instant credit at places like electronics stores and department stores.
Although there are several scoring methods, the score most commonly used by lenders is known as a FICO because of its origins with Fair Isaac And Company. Fair Isaac is an independent company that came up with the scoring method and software used by banks and lenders, insurers and other businesses. Each of the three major credit bureaus (Experian, Equifax and TransUnion) worked with Fair Isaac in the early 1980's to come up with the scoring method.
The three national credit bureaus each have their own version of the FICO score with their own names.
Equifax has the Beacon system, TransUnion has the Emperica system, and Experian has the Experian/Fair Isaac system. Each is based on the original Fair Isaac FICO scoring method and produces equivalent numerical results for any given credit report. Some lenders also have their own scoring methods. Other scoring methods may include information such as your income or how long you've been at the same job.
Until recently, your credit score was not available to you. Only lenders and other businesses that used the score could access it. Fair Isaac and Company felt that the score would only confuse consumers since there was nothing to tell them what it meant or what the lenders were looking for.
In 2001, however, all of this changed due to pressure from the U.S. Congress, industry, and consumer groups. Now you can get your credit score at a number of Web sites, including the big three credit bureaus, and at Fair Isaac's Web site. You can also ask your lender for access to your score when you apply for a loan.
Get your free credit report. The Fair and Accurate Credit Transactions Act (FACTA) has rolled out the right to each consumer for one free copy of his or her credit report from each of the three credit bureaus per year. Check out www.annualcreditreport.com or call
1-877-322-8228
What Does Your Credit Score Mean?
This rating system is meant to develop a snapshot of the risk you currently represent to a lender. Several parameters in your credit file, including length of credit history, number of open accounts, loans, mortgages, public records, and others are formulated to produce a three-digit score between 300 and 900. There are other scores used by lenders and insurance companies
(Some of which are developed by FICO) such as Application and Behavior scores. The other scores take other information into account. Usually a lender will use a combination of your credit score with other factors when determining your risk. They all have the same objective, to determine the borrower's potential risk. Regardless of whether the score was generated by FICO or a system based on FICO parameters, they all yield an industry standard three-digit score. This score places the borrower in one of three main categories.
If your credit score is over 800, you're in the top 10% of the populace.
If your score is about 710, you're right in the middle. (Half of the US population is better, and half is worse.)
If your score is below about 575, you are in the bottom 10%.
Typically, a lender or credit card company sets multiple cutoff points. For example, if you are above 800, you might be offered the Platinum card. If you are above 700, you might be offered the Gold Card. If you are on the border line, your application might be referred to a credit manager for further review.
It is important to remember – what is a bad score for one lender, might be OK to another. (And, there are still some lenders that don't use scores at all.) Lender's set their own policies and cutoff points, and they may target their offerings to people in specific ranges of credit scores.
Typically, a lender or credit card company sets multiple cutoff points. For example, if you are above 800, you might be offered the Platinum card. If you are above 700, you might be offered the Gold Card. If you are on the border line, your application might be referred to a credit manager for further review.
It is important to remember – what is a bad score for one lender, might be OK to another. (And, there are still some lenders that don't use scores at all.) Lender's set their own policies and cutoff points, and they may target their offerings to people in specific ranges of credit scores.
Calculating Your Credit Score
Think of your credit score like you would a grade in school. A teacher calculates grades by taking scores from tests, homework, attendance and anything else they want to use, weighting each one according to importance in order to come up with a final single number (or letter) score. Your credit score is calculated in a very similar manner. Instead of using the scores from pop quizzes and reports you wrote, it uses the information in your credit report.
The number itself can range from 300 to 900. The formula for exactly how the score is calculated is proprietary information and owned by Fair Isaac. Here, however, is an approximate breakdown of how it is determined:
35% of the score is based on your payment history. This makes sense since one of the primary reasons a lender wants to see the score is to find out if (and how timely) you pay your bills. The score is affected by how many bills have been paid late, how many were sent out for collection, any bankruptcies, etc. When these things happened also comes into play. The more recent, the worse it will be for your overall score.
30% of the score is based on outstanding debt. How much do you owe on car or home loans? How many credit cards do you have that are at their credit limits? The more cards you have at their limits, the lower your score will be. The rule of thumb is to keep your card balances at 30% or less of their limits.
15% of the score is based on the length of time you've had credit. The longer you've had established credit, the better it is for your overall credit score. Why? Because more information about your past payment history gives a more accurate prediction of your future actions.
10% of the score is based on the number of inquiries on your report. If you've applied for a lot of credit cards or loans, you will have a lot of inquiries on your credit report. These are bad for your score because they indicate that you may be in some kind of financial trouble or may be taking on a lot of debt (even if you haven't used the cards or gotten the loans). The more recent these inquiries are the worse for your credit score. FICO scores only count inquiries from the past year.
10% of the score is based on the types of credit you currently have. The number of loans and available credit from credit cards you have makes a difference. There is no magic number or combination of types of accounts that you shouldn't have. These actually come more into play if there isn't as much other information on your credit report on which to base the score.
This information is compared to the credit performance of other consumers with similar histories and profiles.
Credit Report Factor Codes
Code # Reason
1 – Amount owed on accounts is too high
2 – Level of delinquency on accounts
3 – Too few bank revolving accounts
3 – Proportion of loan balances to loan amounts is too high
4 – Too many bank or national revolving accounts
4 – Lack of recent installment loan information
5 – Too many accounts with balances
6 – Too many consumer finance company accounts
7 – Account payment history is too new to rate
8 – Too many inquiries last 12 months
9 – Too many accounts recently opened
10 – Proportion of balances to credit limits is too high on bank revolving or other revolving accounts
11 – Amount owed on revolving accounts is too high
12 – Length of time revolving accounts have been established
13 – Time since delinquency is too recent or unknown
14 – Length of time accounts have been established
15 – Lack of recent bank revolving information
16 – Lack of recent revolving account information
17 – No recent non-mortgage balance information
18 – Number of accounts with delinquency
19 – Too few accounts currently paid as agreed
19 – Date of last inquiry too recent
20 – Length of time since derogatory public record or collection is too short
21 – Amount past due on accounts
22 – Serious delinquency, derogatory public record, or collection filed
23 – Number of bank or national revolving accounts with balances
24 – No recent revolving balances
25 – Length of time installment loans have been established
26 – Number of revolving accounts
26 – Number of bank revolving or other revolving accounts
27 – Number of retail accounts
27 – Too few accounts currently paid as agreed
28 – Number of established accounts
28 – No recent bankcard balances
29 – Date of last inquiry too recent
30 – Time since most recent account opening is too short
31 – Too few accounts with recent payment information
31 – Amount owed on delinquency accounts
32 – Lack of recent installment loan information
33 – Proportion of loan balances to loan amounts is too high
34 – Amount owed on delinquent accounts
35 – Payments due on accounts
36 – Length of time open installment loans have been established
37 – Number of consumer finance company accounts established relative to length of consumer
finance history
38 – Serious delinquency, and public record or collection filed
39 – Serious delinquency
40 – Derogatory public record or collection filed
47 – Number of consumer finance company inquiries
97 – Lack of recent auto loan information
98 – Length of time consumer finance company loans have been established
98 – Lack of recent auto loan information
98 – Lack of recent auto finance loan information
99 – Lack of recent consumer finance company account information
When a lender requests a credit score, that score is computed by the credit reporting agency (Equifax, Experian, or Trans Union) based on data in your credit file, and the “secret formula” of the scoring model.
The score is shown on the credit report, along with one or more reason codes, ordered by their importance in arriving at the score. The reason codes may just be numbers that can be looked-up on a chart, or they may be numbers accompanied by the corresponding reason descriptions.
How Lenders Use the Reason Codes
In theory, the reason codes should call attention to areas on your credit report that should be studied further. In practice, the reason codes often are used just to make it easy for the lender to generate a letter of declination, complete with reasons, should you happen to fall below the lender's predefined cutoff.
Interestingly, the same lender might see the same four reason descriptions for a consumer having a much lower or higher score. The reason descriptions often merely provide hints as to what might be improved to get a higher score.
No Adverse Factors
One possible reason message is “No adverse factors” – but it is not often seen. That's because those who develop the scoring models don't know where the lender will place the cutoff points. A lender could have an extremely high standard, but reasons are necessary when an application is declined.
Reasons and the ECOA
According to the Equal Credit Opportunity Act, when declining credit, a lender can't just tell you “Your score wasn't high enough”, or “You didn't meet our internal standards.” A statement of specific reasons must be provided, or you must be advised of your right to demand specific reasons. Credit scoring helps the lender provide reasons.
Your Beacon, FICO, and Empirica credit scores will almost always be different, even though the scoring models within each of them were jointly developed with Fair, Isaac and Co.
A major reason for the difference: Beacon relies on Equifax data, FICO relies on Experian data, and Empirica relies on Trans Union data. The three bureaus don't share information with one another. They have different ways of representing your data. They have different business customers making inquiries about you. Often, there are differences in which companies report to them. This results in scores that could be very different.
A Scoring Model for any Need
Trans Union's Empirica scores come many variations, each of which is different credit score for a different purpose. For example, there is a version for automobile financing, a version for installment loans, a version for bank cards, and a version for personal finance. The same applies to Experian's FICO scores and Equifax's Beacon scores. In addition to the generally available scoring models, many credit grantors have customized models for their own particular needs.
The Old and New Fico Score
From time to time, computation methods and weightings in a scoring model are updated, but many lenders want to stay with the old “algorithm”, because they've built their decision rules over time and they aren't ready to change. So, for example, there's Empirica 95, and the current version of Empirica. There's Beacon 96, and the old version of Beacon. There's FICO and “classic FICO”.
Get your free credit report. The Fair and Accurate Credit Transactions Act (FACTA) has rolled out the right to each consumer for one free copy of his or her credit report from each of the three credit bureaus per year. Check out www.annualcreditreport.com or call 1-877-322-8228.
Your credit score doesn't just affect whether or not you get a loan; it also affects how much that loan is going to cost you. As your credit score increases, your credit risk decreases. This means your interest rate decreases.
There are other factors that influence the interest rate you get for a loan besides your credit score. Things like the type of property you are using the loan to buy, how much of your own money (equity) is going into it, the costs the lender has to make the loan, etc.
PRIME, SUB-PRIME AND SHAFTED PRIME
If your credit score is above 680, you are considered a “Prime Borrower” and will have no problem getting a good interest rate on your home loan, car loan, or credit card.
SUB-PRIME
If your credit score is below 680, you are “Subprime”, and will likely pay a much higher interest rate on your loan.
SHAFTED
Below 560 is the shafted score. At least that is how most lenders and credit issuers perceive it. You can still get a credit card but you will most likely be hit with a security deposit or high acquisition fee. In addition to that your interest rate will likely be 22-23%. You can forget about most home loans and even pay more for your insurance rates. A very low score can even prevent you from getting a job with many companies.
Your credit file may not reflect all your credit accounts. Although most national department store and all-purpose bank credit card accounts will be included in your file, not all creditors supply information to CRA's. Some travel, entertainment, gasoline card companies, local retailers, and credit unions are among those creditors that don't.
If you've been told that you were denied credit because of an ” insufficient credit file ” or ” no credit file ” and you have accounts with creditors that don't appear in your credit file, ask the CRA to add this information to future reports. Although they are not required to do so, many CRA's will add verifiable accounts for a fee. However, understand that if these creditors do not report to the CRA on a regular basis, the added items will not be updated in your file.
Sometimes, there are legitimate reasons why you didn't pay a bill. If a contractor refused to finish a job or did a poor job, then you may have refused payment, but the non-payment may still count against you on your credit report. If there are any unusual circumstances surrounding your credit report that may affect your credit rating – such as a case of identity theft – you can ask that a note be attached to your credit report to explain the problem.
Some lenders will pay attention to this and some will not, but it is a better solution than nothing at all. Such a note will not affect your credit score but will affect your credit report. More importantly, it leaves a paper trail of the problem that lenders can look at if they choose.
Every Credit Bureau allows you to add at least a hundred word statement to your credit report. Company Name, Telephone#, Acct # and basic history in as few words as possible! THIS IS YOUR REPORT.GET ALL OF IT ON THERE!
Get your free credit report. The Fair and Accurate Credit Transactions Act (FACTA) has rolled out the right to each consumer for one free copy of his or her credit report from each of the three credit bureaus per year.
Auto & Home Loans
If you are in a debt repayment plan, your auto and home loan, which are considered secured debt, may not be included. You must continue to make payments to these creditors directly.
Most automobile financing agreements allow a creditor to repossess your car any time you're in default. No notice is required. If your car is repossessed, you may have to pay the full balance due on the loan, as well as, towing and storage costs, to get it back. If you can't do this, the creditor may sell the car. If you see default approaching, you may be better off selling the car yourself and paying off the debt. You would avoid the added costs of repossession and a negative entry on your credit report.
If you fall behind on your mortgage, contact your lender immediately to avoid foreclosure. Most lenders are willing to work with you if they believe you're acting in good faith and the situation is temporary. Some lenders may reduce or suspend your payments for a short time. When you resume regular payments, though, you may have to pay an additional amount toward the past due total. Other lenders may agree to change the terms of the mortgage by extending the repayment period to reduce the monthly debt. Ask whether additional fees would be assessed for these changes, and calculate how much they total in the long run.
If you and your lender cannot work out a plan, contact a housing counseling agency. Some agencies limit their counseling service to homeowners with FHA mortgages, but many offer free help to any homeowner who's having trouble making mortgage payments. Call the local office of the Department of Housing and Urban Development (HUD) or the housing authority in your state, city, or county for help in finding a housing counseling agency near you.
Improving a credit score requires establishing good, clean, current, positive and active credit. This will raise a credit score as soon as it is reported to the credit bureaus and included in the credit file. Begin to pay all of your bills on time and start paying off old debt.
Learn to manage account balances to maximize your credit potential. Credit scores aren't static numbers. Because they are calculated based on your current credit report, they change every time your credit report changes. While this change may be very slight, it can also be much more dramatic. Here are some things you can do to try to improve your score:
Pay your bills on time.
Avoid excessive credit.
Pay down Your Debts.
Have a range of credit types.
Look out for identity theft.
Practice safe banking, safe computing, and safe business practices.
Check your credit score regularly.
Beware of debts and credit you don't use.
Be careful of inquiries on your credit report.
Be careful of online loan rate comparisons. Don't make the mistake of thinking that you only have one credit report.
Don't make the mistake of closing lots of credit accounts just to improve your score.
Don't assume that one thing will boost your credit score a specific number of points.
Don't think that having no loans or debts will improve your credit score.
Never do anything illegal to help boost your credit score.
Some debtors are lead to believe that paying off a credit card bill will boost their credit score by 50 points while closing an unused credit account will result in 20 more points. Credit scores are certainly not this clear-cut or simple.
How much any one action will affect your credit score is impossible to gauge. It will depend on several factors, including your current credit score and the credit bureau calculating your credit score.
In general, though, the higher your credit score, the more small factors – such as one unpaid bill – can affect you. However, when repairing your credit score, you should not be equating specific credit repair tasks with numbers. The idea is to do as many things as you can to get your credit score as close to 800 as you are able. Even if you can improve your credit score by 100 points or so, you will qualify for better interest rates.
Also, remember that some improvements — such as better efforts at making payments on time — may take time to impact your score. So, time is also a factor.
If you go to the bank for a loan and are turned down because your score is too low, your would-be lender will get a list of reasons for that low score. You can use that list to try to turn your score around. While nothing is guaranteed, since lenders can also use their own scoring methods, you certainly can't hurt your score by taking any of these steps.
The key is to get credit only when you need it (unless you're trying to establish your first credit), and then use it carefully and make your payments on time. Remember not to max-out credit cards.
** Pay your bills on time **
One of the best ways to improve your credit score is simply to pay your bills on time. This is absurdly simple but it works very well, because nothing shows lenders that you take debts seriously as much as a history of paying promptly. Every lender wants to be paid in full and on time.
If you pay all your bills on time then the odds are good that you will make the payments on a new debt on time, too, and that is certainly something every lender wants to see. Experts think that up to 35% of your credit score is based on your paying of bills on time, so this simple step is one of the easiest ways to boost your credit score.
Paying your bills on time also ensures that you don't get hit with late fees and other financial penalties that make paying your bills off harder. Paying your bills in a timely way makes it easier to keep making payments on time.
Of course, if you have had problems making your payments on time in the past, your current credit score will reflect this. It will take a number of months of repaying your bills on time to improve your credit score again, but the effort will be well worth it when your credit risk rating rebounds!
** Avoid excessive credit **
If you have many lines of credit or several huge debts, you make a worse credit risk because you are close to "overextending your credit." This simply means that you may be taking on more credit than you can comfortably pay off. Even if you are making payments regularly now on existing bills, lenders know that you will have a harder time paying off your bills if your debt load grows too much.
The higher your debts the greater your monthly debt payments and so the higher the risk that you will eventually be able to repay your debts. Plus, statistical studies have shown that those with high debt loads have the hardest time financially when faced with a crisis such as a divorce, unemployment, or sudden illness.
Lenders (and credit bureaus who calculate your credit score) know that the more debt you have the greater problems you will have in case you do run into a life crisis.
In order to have a great credit score, avoid taking out excessive credit. You should stick to one or two credit cards and one or two other major debts (car loan, mortgage) in order to have the best credit rating. Do not apply for every new credit line or credit card "just in case." Borrow only when you need it and make sure to make payments on your debts on time.
You should also know that taking out lots of new credit accounts in a relatively short period of time will cause your credit score to nosedive because it will look as though you are being financially irresponsible.
** Pay down Your Debts **
If you have a lot of debt, your credit score will suffer. Paying down your debts to a minimum will help elevate your credit score. For example, if you have a $1000 limit on your credit card and you regularly carry a balance of $900, you will be a less attractive credit risk to lenders than someone who has the same credit card but carries a smaller balance of $330 or so. If you are serious about improving your credit score, then start with the largest debt you have and start paying it down so that you are using a less large percentage of your credit total.
In general, try to make sure that you use no more than 50% of your credit. That means that if your credit card has a limit of $5000, make sure that you pay it down to at least $2500 and work at carrying no larger balance. If possible, reduce the debt even more. If you can pay down your credit card to 30% or lower of the high credit limit each month, that is even better. What counts here is what percentage of your total credit limit you are using – the lower the better.
** Have a range of credit types **
The types of credit you have are a factor in calculating your credit score. In general, lenders like to see that you are able to handle a range of credit types well. Having some form of personal credit – such as credit cards – and some larger types of credit – such as a mortgage or auto loan – and paying them off regularly is better than having only one type of credit.
** Look out for identity theft **
Many people who are careful about paying bills on time and having minimal debts are shocked each year to find that they have low credit scores. In many cases, this happens as a result of identity theft. Identity theft is a type of crime in which people take your personal information and steal that information to pose as you in order to get access to your accounts or identity.
For example, someone with your PIN numbers can remove small amounts of money from your bank account each month or someone can use your name and personal information to get credit cards in your name and use those credit cards with no intention of paying back the money. You are stuck with the large debts and the poor credit score.
To prevent identity theft, always check your account statements carefully each month. Report any suspicious activity or any charges you don't recognize at once. Also check your credit report regularly and immediately investigate any new credit accounts you do not recognize – this is the best way of detecting and acting on identity theft.
If you have been the victim of identity theft, report to the police at once and get a police statement. Send copies of this to your bank and credit bureaus. Better yet, get the credit bureaus to attach the report to your credit report, if you can. Close all your accounts and reopen new ones. You should not have to pay for someone else's illegal activity.
** Practice safe banking, safe computing, and safe business practices **
** Check your credit score regularly **
** Beware of Debts and Credit you don't use **
** Be careful of Inquiries on your credit report **
** Be careful of Online Loan Rate Comparisons **
** Don't make the mistake of thinking that you only have one credit report **
** Don't make the mistake of closing lots of credit accounts just to improve your score **
** Don't assume that one thing will boost your credit score a specific number of points **
I hope this helps and thank you!
My goal is to raise awareness of the credit process and how, with proprietary information, anyone can raise their credit score and permanently delete all negative items from their credit reports. PhoenixCredit.org
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