Month: November 2013

How is a Credit Score Calculated?

People often ask how their credit score is calculated and why they have a different credit score from each of the 3 credit bureaus (Experian, Equifax and Transunion).

Nearly everyone has heard the term FICO and believe there to be just one way a FICO score, or credit score is calculated. That’s not true. The company that came up with the FICO scoring method (Fair Isaac Corporation) has actually released several versions of the scoring model. And, other models exist such as the VantageScore model. Then of course, just to complicate it even more the 3 credit bureaus use variations of each.

credit score

On top of that you must realize that creditors do not report to all 3 credit bureaus in many cases. Why? Because it costs them money to report to the bureaus. This is not a free service offered. Make no mistake. The credit bureaus are billion dollar companies making huge profits on being a receptacle for your information and selling that information to large corporations that want to advertise to you, and need to pull your credit report to evaluate your credit worthiness in order to sell to you. Therefore, a creditor may decide to only report to one or two of the bureaus. This will create even more of a difference of your score from bureau to bureau.

Don’t let all this confuse you. Keep it simple and pay attention to what you can control, and control it well. Here is what really matters regarding your credit score and the weight applied to calculating your credit score.

Payment History- 35% of your credit score

  • Current payment record on car loans, mortgages, installment loans, retail accounts, credit cards. What you are looking for is a “paid as agreed” status listed for these accounts on your credit report
  • Public records such as bankruptcies, foreclosures, liens of any kind, judgments, wage garnishments
  • Past due amounts listed
  • Any past delinquencies even if the balance is now current or the account is closed with a zero balance

Payment History Advice

  • Pay your bills on time or even ahead of time. Recent late payments can impact your score dramatically. Paying ahead of schedule can result in lower balances being shown on your report.
  • Get any past due accounts current.
  • Closing accounts with a good history may also impact your score. Think carefully before you close accounts.

Balances Owed- 30% of your credit score

  • The ratio of the balance you owe versus your credit limit on each account and in total will dramatically affect your credit score

Advice on Balances Owed

  • Keep balances owed on credit cards and store accounts low. There is conflicting advice on this but they should never be above 30%.
  • As stated above, if you pay your credit card payments before they are due and pay them in full you’ll be able to show a zero balance each month.
  • Don’t open new accounts just because you can. This can actually lower your score.

Length of Credit History- 15% of your credit score

  • Age of existing accounts
  • Number of recently opened accounts
  • Time since the latest account activity
  • Ratio of new credit versus established credit
  • Re-establishment of new credit following adverse payment problems

Advice on Credit History

  • If you are young and do not have a credit history dating back decades be careful not too open too many accounts quickly. This can be perceived as a risk factor.
  • If you are trying to establish or re-establish a credit history, open an account and use it wisely. Pay it off each month. Then open a second account several months later and do the same. Opening 4 new accounts at once is not a good strategy.
  • Stay away from consumer finance companies if possible. Future creditors know that they lend to consumers with less than perfect credit.

Types of Credit- 10% of your credit score

  • The number and type of accounts you have opened

Advice on Types of Credit

  • Because this accounts for a small percentage of your overall score don’t open accounts just to open accounts. If you have a car loan pay it each month. However, if you have a car that is paid for do not refinance it simply to have a car loan on your credit report.
  • It is good to have a credit card. Do not shy away from opening a secured or unsecured credit card account because you had problems in the past. Open an account and use it only for items you need anyway such as groceries, gas, etc. Then pay it off every month.

New Credit and Credit Inquiries- 10% of your credit score

  • Recently opened accounts versus the number of inquiries by potential creditors
  • Recently opened accounts versus the number of inquiries by potential creditors
  • Time since the inquiries
  • Time since account was opened

Advice on Credit Inquiries

  • The only types of inquiries you need be concerned with as it relates to your credit score are “hard inquiries”. These are inquiries you authorized to be made for the purpose of evaluating you as an applicant for credit.
  • Excessive inquiries in a short time can cause your score to go lower. If you are denied credit by one company do not apply at 5 more companies to see if they will give you credit. This will show up as potentially excessive.
  • When trying to buy a car, dealers may contact several finance companies within a day or two to see if they can find one to give you a loan, or the best deal. This can cause your score to go lower in some scoring models. Others give you a period of days for these type inquiries. Before walking into a dealer to buy a car go to your bank or credit union and see about a loan from them. If you cannot qualify do buy the car. If you can walk into the dealership with financing in place.