Understanding Your Credit Score

What Credit Score Means and How Is It Derived?

Lenders have to consider various factors while deciding to approve a loan, including credit scores. The most commonly used credit scores are credit bureau risk scores developed by Fair, Isaac, and usually referred to as FICO scores.

The score is a number that means little to a layman but potential lenders can look at these numbers and judge the likelihood of a loan being repaid by an individual and whether payments will be made punctually. Lenders get these credit scores and reports from credit-reporting agencies. These agencies use a mathematical formula to derive the score by scrutinizing details in the credit report that the agency holds for an individual. These details are compared with trends observed in past credit reports to understand what an individual’s credit risk may be.

Lenders can access FICO scores through the major credit reporting agencies (Experian, Equifax, and Trans Union). Scores from a particular agency will consider only information on the individual’s credit report at that particular agency. Thus, different agencies may give the same individual different scores. A low risk individual will have a high score.

A FICO credit bureau risk score is the best available guide to credit risk that is based completely on data found in credit reports. Other kinds of scores are also available. However no score can say whether an individual will be a good customer or a bad one. Additionally, many lenders may use FICO scores as only one part in their decision-making strategy for lending. There is no set score level that is accepted by all lenders.

The credit-reporting agency arrives at FICO credit bureau risk scores using Fair, Isaac’s scoring models when a lender requests the score. The credit agency in question has the data required and Fair, Isaac cannot neither access nor correct this data nor can it calculate a score.

FICO Credit Data Categories

There are five kinds of primary information considered by a Fair, Isaac score. Bear in mind that:

• None of these factors are omitted or singled out by a score; it looks at all of them. The score is not based solely on any particular information or detail in your report but rather on all of it.

• Each factor is important but the weightings may vary. For any two people who do not have the same credit history, factors may vary in their relative importance in the over-all score. It is therefore not possible to precisely gauge the importance of any particular factor in arriving at a score. The levels of significance explained here are valid for the general population.

• The FICO score does not consider any information that is not included in your credit report. Lenders may look at your income and the sort of credit you are seeking and other information when making their decisions, however this information is not considered in your score which merely takes into account your credit report at the credit-reporting agency.

• The score takes into account all information in your report, whether positive or negative. The score will be lowered if you pay late and will increase if you consistently pay on time.

• In accordance with U.S. law, ethnicity, religious affiliation, marital status, gender and nationality are factors that are excluded from the calculation of credit score.

Your Payment History (35% of Score)

A lender’s first task will typically be in ascertaining how punctual you have been in the past in the payment of credit accounts. This being said, one or two late payments will not automatically bring your score down drastically. If the rest of the credit rating information is good, late payments may not matter. However, payment track record is one factor that is considered when calculating your credit score.

Your score does consider the following:

• Payment records and details on various sorts of accounts: Among these are accounts for credit cards, retail accounts, installment loans, finance company accounts and mortgage loans.

• Public record and collection issues: These constitute reports of bankruptcies, credit-related judgments, suits, liens, wage attachments and collection items. All of these are carefully considered but how recently any of them have occurred is important. The more recent an event, the more seriously it is considered.

• Details of late or missed payments and public record and collection items: Specifically, how late these payments were made, how much was the amount of money in question, how recently they occurred and how many of them exist in an individual’s record are of primary importance. A payment made 30 days late has, a lower risk factor than a payment that is 90 days late. However, how recent a late payment has been and how often the individual pays late are also important influential factors. Bear in mind that if you close an account on which you had made a late payment at any time the late payment still remains on your credit report. The number of accounts that show no late payments constitutes an important consideration. A good track record on most of your credit accounts will increase your credit score.

Amount of Money Owed (30% of Score)

Money owed on a credit account will not, in itself, be taken to mean that credit is risky. At the same time if you owe large sums simultaneously on several different accounts you may be considered more likely to make payments late or default on them entirely. One of credit scoring’s most important functions is understanding exactly how much money owed is unfavorable in relation to the credit profile being examined.

In this regard, the following points are considered in deducing your score:

• The amount of money owed on all accounts: Do not forget that even if all your credit cards have been paid off in full each month, the credit report may display a balance on those cards. This is because the amount on your credit report is the balance on your last statement.

• The amount owed on each of various kinds of accounts: The score does not only consider how much money you owe in all; it will also take into account the amount of money owed in different kinds of accounts you may have; for instance, the amount owed on credit cards and the amount owed on installment loans.

• Whether your report shows a balance on particular kinds of accounts: A small balance and punctual, regular payments may indicate good management of credit; in fact, this situation may even be better than not having any sort of payment balance at all. However if you close any unused credit accounts with no payment balance and a good record, your score will probably not improve.

• The number of your credit accounts that have balances: A large number of unpaid balances on various credit accounts can mean that you are unable to manage your credit properly.

• The extent to which your total credit is used on credit cards and other "revolving credit" accounts: If you are reaching your maximum credit limit with several different cards you may be considered likely to find future payments difficult.

• The amount you owe on installment loan accounts as compared with the original amount of the loan: For instance, $10,000 borrowed as a car loan with $2,000 paid back means that 80 percent of the original loan is still pending with interest. Paying off pending installment loans as quickly as possible is usually an indication that you can manage your loans and credit and will probably repay debts promptly.

Length of Credit History (15% of Score)

A longer credit history is likely to increase your score. Even then, depending on the rest of the credit report, an individual with a short credit history may get a high score. The following factors are of significance:

• The length of time your credit accounts have been established in general: The length of existence of your oldest account is taken into account when scoring along with the average length of existence of all accounts.

• The length of time in which specific credit accounts have been established.

• The time lapse since certain accounts have been used.

New Credit (10% of Score)

New credit is easier to get and more often sought now than in the past. However, research does prove that several new credit accounts opened in a limited period of time can equate to a higher risk, especially if the individual opening new accounts does not have a long credit history.

Your score will differentiate between seeking new credit accounts and simply trying to get better rates. The latter is not considered to be an indicator of high risk. In these cases your score considers the following:

• The number of new accounts: New accounts are looked at not only with regard to their number but also with regard to the number of new accounts per type of account. The number of new accounts in relation to the total number of accounts an individual has is also considered.

• How long since you last opened a new account:

• The quantity of recent requests for credit made by you: This is seen from the number of inquiries directed to the credit-reporting agencies. The score will not take into consideration any inquiries you have made about your own credit report. Additionally, scores do not reflect inquiries made by a lender in relation to "pre-approved" credit offers or account reviews that show up on your credit report.

• Whether payment difficulties in the past have been followed by a positive recent credit history. Punctual payments after a series of late ones will help improve a score.

Kinds of Credit Being Used (10% of Score)

The combination of credit types will also be used to calculate your score. It is unnecessary to have one of each kind of account especially if you do not plan to use certain kinds at all. The credit combination is a minor factor in arriving atscore.

Your score will consider:

• The different types of credit accounts, the number of accounts of each type and the total number of credit accounts.

Credit Score Reason Codes

Along with your FICO score, “score reason codes” may be delivered to the lender to explain why your score is not higher. While the score itself may be difficult to understand, these reason scores can help you to see if your credit report may contain errors and understand how it might be improved.