When a credit file is sold to a member creditor, it contains a Credit Score that has meaning to a prospective creditor. At a glance, the creditor can determine the relative risk of granting you credit. This Credit Score was developed by the firm Fair, Isaac and Company and is known as the “FICO Score” (Equifax’s version is called a “Beacon Score”). The score range is approximately 350 to 850. The higher the score, the less of a credit risk you are considered to be. Further in this article we will examine different scales for these scores and what they say about one’s credit worthiness.
An important point to know is that until recently, the credit file version provided to consumers did not even include credit scores. It was published only in the version given to bureau members (creditors). As of 2001 credit scores became available to consumers by going on to the Fair, Isaac and Company web site at: www.myfico.com. For a fee charged by each credit bureau, you can access your credit reports which contain your Credit Scores. Each individual credit bureau, Equifax, Experian and Trans Union also has this availability on their web sites.
If you are in the market for a new home mortgage or a car loan, it’s a good idea to find out your Credit Score before applying for the loan for a couple of reasons. One is to see if there are problems present which you don’t know about. This way the problems can be addressed before applying. The other reason is to make certain the creditor is offering you a fair rate for the score you have. They may advise you that your score isn’t quite good enough so they can charge a higher interest rate when in fact your Credit Score is more than acceptable. On a following page you will find a credit scoring scale that will be helpful in knowing how to gauge your particular score.
The calculations that make up a Credit Score are developed by looking at the way millions of consumers manage their credit. Credit Scores have proven over time to be a reliable indicator of whether or not a consumer would repay a loan. A score is determined by summarizing many factors in your credit report. These factors are identified on the following page along with approximations of how each are weighted according to Fair, Isaac and Company:
Payment History (approximately 35% of score) – How you paid your bills in the past gives the lender some indication of how you can be expected to pay them in the future. How often you have been late paying your bills, how recently your payments have been late as well as how long you remained delinquent on any bill at one time are important factors. For instance, being 90 days late will affect the score much more than 30 days late and mortgage late payments are significantly more adverse. Generally late payments more than 2 years old don’t impact the score as much.
Outstanding Debt (approximately 30% of score) – The lender wants to know proportions of balances to credit limits. In other words, they want to know how much credit you have and how much you have used. Research has shown that the number of credit accounts you have as well as how much of your available credit is used is important. If your total debt is more than 75% of your credit limit, your score is drastically reduced. It is best to keep the balance at 35-50% of the credit limit.
Length of Credit History (approximately 15% of score) – Generally, the longer you have had and have successfully managed credit, the higher your credit score.
Number of Credit Cards / Credit Inquiries (approximately 10% of score) – The rule of thumb is that you need at least two credit cards to be able to have a good score. However, more than five credit cards may lower your score. Applying for too much new credit is probably one of the easiest ways for people to inadvertently harm their credit scores. In that regard, too many inquiries in a short period of time signals that a consumer may be seeking credit because of a financial problem. The score will reduce with more than 4 inquiries in the last six months and 6 within the last year. However, the credit report data used to calculate credit scores does not include auto or mortgage loan inquiries that occur in the 30-day period prior to the score being calculated. Auto and mortgage inquiries that occur within a 45-day period are considered as only one inquiry.
Types of Credit (approximately 10% of score) – A mixture of types of credit such as credit cards, personal loans, mortgages, etc. is more positive than having just a certain type of established credit. If you have indebtedness strictly with finance companies instead of bank credit cards, it will be a negative for your score because the perception is that you have had to go to high interest finance companies due to past financial problems.
Other Factors – There are several other important considerations that are taken into account by the credit bureau computer models when determining their scores. The following factors somewhat overlap those already discussed and their relative weights are not known:
- Unsatisfied Debt – Old debt obligations that are in the form of collection or charged off accounts look worse than even a bankruptcy. This affects the score significantly as prospective lenders do not want to offer credit to someone who has the profile of not honoring their obligations. Also, if there is an unpaid debt of significance, a mortgage lender will not want to approve a loan because there is the possibility that an additional lien holder could utilize the court to obtain a judgment. Therefore it is always advisable to pay off an unsatisfied debt. A paid charge off or collection account will increase the score as opposed to just keeping the account unsatisfied.
- Zero Balances – Research shows that consumers with no balances get lower scores than those with moderate balances. The reason is that lenders fear the consumer with no balance could go on a spending spree with the available credit and incur new debt. That is why if you practice never carrying a balance, which is certainly commendable, it is recommended that your credit cards carry only moderate credit limits. But you should also know that if you pay off your credit cards at the end of each month, the scoring models will pick up that you charged on those cards but not the fact that you paid them off immediately. Therefore, you will want your charge balances to stay below 50% of your credit limits even though you pay them off at the end of the month. Closing out cards that you never use will also help with the issue of too much available credit. Remember though that it is better to close newer credit card accounts than older ones because you want to preserve the positive payment history.
- Balance Transfers – Generally, four or more balance transfers over a 12-month period will lower your score. It is perceived that consumers who have to transfer balances use debt beyond their means. If you do transfer between accounts, you should close the old account and plan on staying with the new account for at least two years.
- Demographics – Besides the information contained on the credit report, the score is also based on certain demographic characteristics such as:
- Married is better than single with the most favorable age group being 25-65.
- Also, more than three dependents will tend to lower your score.
- Steady employment is a positive for the score especially after 6 years. Also, occupation is a factor with professionals getting the higher scores, skilled workers next and unskilled employees achieving the lowest scores.
- The score will be better for homeowners than renters.
- Income under $1,000 per month is a negative and over $3,000 a positive.
- The score will be better if you have a bank account and a telephone in your name.
The following table is an example of a credit scoring scale that most lending institutions use in their approval process. Score ranges play a significant part in determining the interest rate a lender charges, the higher the FICO Score the lower interest rate the consumer pays.
Above 750 = Excellent
720 to 750 = Very Good
700 to 719 = Good
680 to 699 = Above Average (680 = benchmark for easy loan approval)
660 to 679 = Solid (660 to qualify for conforming A-rate mortgage
620 to 659 = Fair
600 to 619 = Marginal
580 to 599 = Below Average
550 to 579 = Well Below Average
525 to 549 = Poor
500 to 524 = Very Poor
under 500 = Unacceptable (unable to attract any type of credit)
