What is a credit score?

A credit score is a number that is calculated based on an individual’s credit history, and it gives lenders a quick snapshot of consumers who are applying for credit or loans. This number helps companies estimate the level of risk associated with lending a specific consumer money or extending that consumer a line of credit. Generally speaking, consumers with higher FICO scores should be able to be approved for lower interest rates, which usually translates into lower payments.

A credit score can range from 300 to 900. The formula for exactly how the score is calculated is proprietary information and owned by Fair Isaac. Although there are several scoring methods, the score most commonly used by lenders in the United States is known as a FICO because of its origins with Fair Isaac and Company, traded publicly under the symbol FIC.

Fair Isaac is an independent company in the United States 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 their own scoring method.

The same end result can come through reviewing the actual credit report, which lenders may also 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.

Here is a breakdown of how your credit score is most likely determined:

35% of the score is based on your payment history 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.

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? Generally speaking, the more cards you have near their limits, the lower your score will be. A good rule of thumb is to keep your card balances at 25% or less of their limits.

15% of the score is based on the length of time you have had credit. Generally speaking, the longer you’ve had established credit, the better it is for your overall credit score.

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. Generally speaking, 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). Generally speaking, the more recent these inquiries are, the more they will affect your credit score (negatively). 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 can make a difference.

Each individual has his/her own unique credit history, so the above breakdowns may or may not relate exactly to his/her credit score. But the breakdowns do provide a good starting point for understanding your credit score, as well as steps that you can take to increase your credit score.

As a consumer, you can also get information on your own credit score by using myFICO, which is the consumer division of Fair Isaac. myFICO offers informative credit information products that help people understand actions they can take to improve and protect their overall financial health.

Posted in Credit Cards, Loans, Miscellaneous, Personal Finance

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