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What Is a Credit Score?


Learn what your credit score is, and how to understand it.

A credit score, commonly known as FICO scores, are used by creditors to determine how good a credit risk you are. It has predictive value for telling the lender how likely you are to repay a loan or to make payments on time.

The credit score is calculated using information in your credit reports. Usually each person living in the United States who has a Social Security number, whether a citizen or not, will have three versions of credit reports to their name. Equifax, Experian and TransUnion are three companies collect your credit information and provide your credit report (also known as credit profile) to your lenders/creditors.

The credit score is based on a model derived from analysis of past credit history of thousands of people. Based on the collective "credit history" of thousands of people with financial profile similar to yours, the credit score tries to estimate your future behavior in respect to repayment of your loans, making timely payments, etc.

Described below are the five main categories of information on your credit report that are used in the calculation of your credit score, along with their general level of importance. Within these categories is a complete list of the information that goes into a FICO score. Be aware that:

 - A score takes into consideration all these categories of information, not just one or two. No one piece of information or factor will determine your score.

 - The importance of any factor depends on the overall information in your credit report. For some people, a given factor may be more important than for someone else with a different credit history. In addition, as the information in your credit report changes, so does the importance given any one factor in determining your score. Because the details of your financial situation are unique, and the exact formula used in calculation of your credit score is kept secret, it is not possible to predict what factors will bear the most weight in your situation. Thus, it's impossible to say exactly how important any single factor is in determining your score - even the levels of importance shown are for the general population, and will be slightly different for different credit profiles. What's important is the mix of information, which varies from person to person, and for any one person over time.

 - Your score only looks at information in your credit report. Lenders look at many things when making a credit decision, including your income and the kind of credit you are applying for. However, your FICO score does not reflect these facts, as it only evaluates your credit report at the credit reporting agency.

 - Your score considers both positive and negative information in your credit report. Late payments will lower your score, but having a good record of making payments on time will raise your score.

 - Your score does not consider your ethnic group, religion, gender, marital status and nationality. These are, in fact, prohibited from use in scoring by US law.

The Five Things That Count

1) Payment History:
Approximately 35% of your score is based on your Payment History.

The first thing any lender would want to know is whether you have paid past credit accounts on time. This is also one of the most important factors in a credit score. However, late payments are not an automatic "score-killer." An overall good credit picture can outweigh one or two instances of, say, late credit card payments. By the same token, having no late payments in your credit report doesn't mean you will get a "perfect score." Some 60-65% of credit reports show no late payments at all your payment history is just one piece of information used in calculating your score.

Your score takes into account:

 - Payment information on many types of accounts. These will include credit cards (such as Visa, MasterCard, American Express and Discover), retail accounts (credit from stores where you do business, such as department store credit cards), installment loans (loans where you make regular payments, such as car loans), finance company accounts and mortgage loans.

 - Public record and collection items - reports of events such as bankruptcies, judgments, suits, liens, wage attachments and collection items. These are considered quite serious, although older items will count less than more recent ones.

 - Details on late or missed payments and public record and collection items - specifically, how late they were, how much was owed, how recently they occurred and how many there are. A 30-day late payment is not as risky as a 90-day late payment, in and of itself. But recent payments and frequency count too. A 30-day late payment made just a month ago will count more than a 90-day late payment from five years ago. Note that closing an account on which you had previously missed a payment does not make the late payment disappear from your credit report.

 - How many accounts show no late payments. A good track record on most of your credit accounts will increase your credit score.

2) Amounts Owed:
30% of your score is based on Amounts Owed.

Having credit accounts and owing money on them does not mean you are a high-risk borrower with a low score. However, owing a great deal of money on many accounts can indicate that a person is overextended, and is more likely to make some payments late or not at all. Part of the science of scoring is determining how much is too much for a given credit profile.

Your score takes into account:

 - The amount owed on all accounts. Note that even if you pay off your credit cards in full every month, your credit report may show a balance on those cards. The total balance on your last statement is generally the amount that will show in your credit report.

 - The amount owed on all accounts, and on different types of accounts. In addition to the overall amount you owe, the score considers the amount you owe on specific types of accounts, such as credit cards and installment loans.

 - Whether you are showing a balance on certain types of accounts. In some cases, having a very small balance without missing a payment shows that you have managed credit responsibly, and may be slightly better than no balance at all. On the other hand, closing unused credit accounts that show zero balances and that are in good standing will not generally raise your score.

 - How many accounts have balances. A large number can indicate higher risk of over-extension.

 - How much of the total credit line is being used on credit cards and other "revolving credit" accounts. Someone closer to "maxing out" on many credit cards may have trouble making payments in the future.

 - How much of installment loan accounts is still owed, compared with the original loan amounts. For example, if you borrowed $10,000 to buy a car and you have paid back $2,000, you owe (with interest) more than 80% of the original loan. Paying down installment loans is a good sign that you are able and willing to manage and repay debt.

3) Length of Credit History:
15% of your score is based on Length of Credit History.

In general, a longer credit history will increase your score. However, even people with short credit histories may get high scores, depending on how the rest of the credit report looks.
Your score takes into account:

 - How long your credit accounts have been established, in general. The score considers both the age of your oldest account and an average age of all your accounts.

 - How long specific credit accounts have been established.

 - How long it has been since you used certain accounts.

4) Are You Taking on More Credit:
10% of your score is based on New Accounts.

People tend to have more credit today and to shop for credit - via the Internet and other channels - more frequently than ever. Fair, Isaac scores reflect this fact. However, research shows that opening several credit accounts in a short period of time does represent greater risk - especially for people who do not have a long-established credit history. This also extends to requests for credit, as indicated by "inquiries" to the credit reporting agencies - an inquiry is a request by a lender to get a copy of your credit report.

The scores distinguish between searching for many new credit accounts and rate shopping, which is generally not associated with higher risk. In part, this is handled by treating a grouping of inquiries - which probably represents a search for the best rate on a single loan - as though it was a single inquiry.

Your score takes into account:

 - How many new accounts you have. The score looks at how many new accounts there are by type of account (for example, how many newly opened credit cards you have). It also may look at how many of your accounts are new accounts.

 - How long it has been since you opened a new account. Again, the score looks at this by type of account.

 - How long it has been since you opened a new account. Again, the score looks at this by type of account.

 - How many recent requests for credit you have made, as indicated by inquiries to the credit reporting agencies. Note that if you order your credit report from a credit reporting agency such as to check it for accuracy, which is a good idea the score does not count this. This is considered a "consumer-initiated inquiry," not an indication that you are seeking new credit. Also, the score does not count it when a lender requests your credit report or score in order to make you a "pre-approved" credit offer, or to review your account with them, even though these inquiries may show up on your credit report.

 - Length of time since credit report inquiries were made by lenders.

 - Whether you have a good recent credit history, following past payment problems. Re-establishing credit and making payments on time after a period of late payment behavior will help to raise a score over time.

5) Types of Credit in Use:
10% of your score is based on Types of Credit in Use.

According to the information provided by the Fair & Isaac, the creater of FICO credit score, about 10% of your credit score is based on:

 - What kinds of credit accounts you have, and how many of each. The score is a complex formulat that takes into account both the types of account, their mix and the total number of credit accounts you have under your name.

 - Credit account types include: credit cards, retail accounts, installment loans, finance company accounts and mortgage loans. In general, the effect of how many accounts you have and their mix would vary with your income and other factors. It is not recommended that you open new accounts just to "diversify" your credit profile. This part of the credit score is more important if you do not have a lot of other credit information on your file, as would happen for example to young adults.

Final Word: If you are totally confused at this point - don't feel alone. The best way to not have to worry about a negative profile, is to make your payments on time. It's much easier (although it might not be EASY) to pay on time than spending years cleaning up a negative credit history.

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