Archive for October, 2009

How Credit Scores are Calculated

Credit scores range anywhere from 300 to 850. The formula, created by Fair Isaac, is used to calculate your credit score. Here is how it’s determined:

  • 35% of it is based on your payment history. The score is affected by how many times your bills have been paid lately and how many times you have had bankruptcies in the past. When collections and bankruptcies happen also play a role, the more recent, the worse it will be more your overall score.
  • 30% of this score is based on your outstanding debt. This part includes the amount you owe on your car, home or loans as well as the number of credit cards you have and their credit limits. The main rule here is to keep your card balances at 25% or even less of their limits.
  • 15% of the credit score is based on the length of time you have had such credit. The longer you had good established credit, the better it is for you overall credit score.
  • 10% of the score is based on the amount of inquires on your report. For example, if you currently have a lot of credit cards or loans, you will have a lot of inquires on your credit report. These inquires are generally bad for you since it means that you are in some financial trouble and thus need the funds to get out of debt. Moreover, the more recent those inquires are, the worse effect it has on your credit score.
  • 10% of the credit score is based on any other types of credit you have now. These are the number of loans you have and the number of credit requests.

Introduction to Credit Scores

People want to get credit for a lot of reasons – to purchase a house, car, or even obtain a student loan. But, did you know that there is a unique number, which determines whatever you can get those things or not and how much it will cost you? Moreover, that three digit number is called a credit score.

First off, your credit report determines your credit history: how you have paid your bills, how much open credit you currently have and everything else that might effect your credit score. Your credit score is so powerful that it sums up all of your credit history only into three numbers. This three digit number is used to help lenders decide whatever they should give you a loan or not.

Credit score helps any lender identify possible level of risk they need to assume when they lend you money. Although, the same could be done by reviewing you credit report, credit score tends to more more accessible and easier to interpret. The system gives points based on the information provided in your credit report. With this information, lenders can easily determine if someone will repay a loan or not as well as make payments on time.
The most commonly used credit scoring method by lenders is FICO. The major three national credit bureaus have their own versions of the FICO. For example, Equifax has the Beacon system, TransUnion has the Emperica system, and Experian has the Experian / Fair Isaac System.

What is a Good Credit Score?

The answer to this question everything depends on your lender and the way they rate and determine what is a good credit score. It’s highly recommended that you speak to your lender and discuss this question; however we can make general assumptions here, when we consider standard FICO scores, which go up till 850:

  • 750 or higher: this tends to be an excellent credit score. With a 770 credit score, you can obtain the best credit loan rates possible.
  • Between 700 and 750: 725 is an average credit score in the United States. The credit scores here range between excellent to good credit score.
  • Between 700 and 650: considered to be a very good credit score. Again, the score varies in different industries.
  • Between 650 and 600: just a good credit score. Often the minimum for a good credit score is established at 620 since this is the cutoff for the prime credit loan rates.
  • Below 600: this seems to be a high lending risk for lenders. Although you still can obtain loans and credit cards, they all will be secured.
  • Below 550: considers to be an awful credit score – bankruptcies, past-due accountants and so on.

How to Achieve a Perfect Credit Score

The ultimate goal as you might already know is to reach a credit score of 800 or above. Here is a collection of some useful tips, which show you exactly how to go about it:

  • Don’t make late payments: late payments can effect you for up to 24 months or even longer.
  • Avoid bankruptcies: they are very difficult to remove and most of the time stay for up to 10 years.
  • Have as little credit cards as possible: although diversity of credit is essential for the perfect credit score, having too many credit cards effects your credit score negatively.
  • Keep credit card balance to 15% or less: very important – it has been established that balances at 15% or below are ideal for the perfect credit score.
  • Have a mortgage: it has been proven that stability and long term credit history, which is associated with mortgage, is very important for your perfect credit score.
  • Grow old: it has been well documented that age helps with credit score ratings.  It’s just about impossible to reach a perfect credit score of 850 without being in your mid fourties or above.

Factors Affecting Your Credit Score

As you become older and older, you realize that credit score is one of the most important numbers, which affects your financial life. The more you know about credit scores, the easier it will be for you to have a healthy financial life and thus more opportunities to have loans with the prime rates. The following factors play a major role on your credit score:

  • Repayment history: this factors carries the most weight on your credit score. Experts in the industry say that this factor alone accounts for the 35% of your credit score.
  • Outstanding debt: the next in line comes in your debt. This factor plays 30% of your credit score.
  • Length of the credit history: the longer your credit history is, the better it is. This factor weights about 15%.
  • State of the accounts: the amount of money, you have in your account. This factor is about 10% of the total credit score.
  • Different credit types: the types of loans you have taken out, have an affect on your credit score as well. Whatever it is a secure, unsecured loan or just debt consolidation matter. Finally, the factor has another 10% of the credit score.

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