Your FICO score (www.myfico.com) is the most commonly used credit scoreNumeric value compiled from information in a credit report using a standardized formula that ranks the risk of default according to the person’s credit history. A score is based on past payment history, the amount of credit available, and other factors. , and is a measure of your ability to pay back your debts over time. It is a number from 300-850 that is determined by a variety of factors such as your track record of paying bills on time, the amount of creditThe borrowing capacity of an individual or company. A transaction in which a borrower (or debtor) receives goods, services, or cash and agrees to repay the lender at a future date, usually with certain costs. you were able to secure, and the length and type of credit you made payments on.
Banks and lenders use your score to help determine how risky it might be to lend you money. It is important to understand what determines your credit score and how your behavior affects your score, so you can put yourself in the best position possible to borrow money easily and at the lowest cost possible.
How is it Calculated?
Your credit score is calculated by combining the different transactions that show up in your credit reportInformation gathered from businesses and companies with which a person has a financial/business relationship (present or past). These could include department stores, banks, credit card issuers, and mortgage companies. Information on tax liens, bankruptcies, and lawsuits comes from court records. One free annual report can be ordered once every 12 months from each of the three major consumer-reporting agencies. . Often each of the Credit Bureaus, (Experian, TransUnion, and Equifax), produce similar credit scores, but it is important to check all three to be sure.
According to credit score provider myFICO.com, credit bureaus generally use 5 factors to determine your FICO, or credit score: Payment History, Amounts Owed, Length of Credit History, New Credit, and Types of Credit Used.
Mouse over each category below to learn how each factor is determined.
- Payment information on specific types of accounts (credit cards, retail accounts, installment loans, finance company accounts, mortgage, etc.)
- Presence of adverse public records (bankruptcy, judgments, suits, liens, wage attachments, etc.), collection items, and/or delinquency (past due items)
- How long and the amount past due on delinquent accounts or collection items
- Number of past due items on file
- Number of accounts paid as agreed
- Amount owing on accounts
- Amount owing on specific types of accounts
- Lack of a specific type of balance, in some cases
- Number of accounts with balances
- Proportion of credit lines used (proportion of balances to total credit limits on certain types of revolving accounts)
- Proportion of installment loan amounts still owing (proportion of balance to original loan amount on certain types of installment loans)
Length of credit history
Length of Credit History
- Time since accounts opened
- Time since accounts opened, by specific type of account
- Time since account activity
- Number of recently opened accounts, and proportion of accounts that are recently opened, by type of account
- Number of recent credit inquiries
- Time since recent account opening(s), by type of account
- Time since credit inquiry(s)
- Re-establishment of positive credit history following past payment problems
Types of credit used
Types of Credit Used
- Number of (presence, prevalence, and recent information on) various types of accounts (credit cards, retail accounts, installment loans, mortgage, consumer finance accounts, etc.)
- 1data from myFICO.com
FICO® Score Range
- Not Bad
- Very Good
A Low Credit Score Can Cost You Money
Your credit score often determines the interestAn amount of money paid for using funds over a period of time, generally an annual percentage rate. Bank interest is both an amount paid to depositors of funds and a finance charge for money that is borrowed. The price that someone pays for the temporary use of someone else’s funds. Interest is also a compensation that someone receives for temporarily giving up the ability to spend money. rate you pay on your credit cards and loans. A poor credit score signals to a bank that it could be risky to lend you money because you’re less likely to be able to pay the loan back. Banks and lenders may still approve you for a loan, but at higher interest rates and with higher borrowing costs.
These higher interest rates might cost you hundreds of dollars more in monthly payments. Over the life of the loan, this could cost you thousands of dollars on an auto loan and even hundreds of thousands on a larger loan such as a home mortgage.
Lower credit scores can also mean more difficulty in obtaining employment in certain industries. Automobile, homeowner, and life insurance companies also use credit scores to determine your premiumAn amount to be paid for a contract of insurance. A sum added to interest, wages, etc; a bonus. . Lower scores mean higher premiums. That's one reason why it's important to monitor your credit report, and maintain or improve your credit score at all times, even when you are not about to make a large purchase like a house or car.
Building Your Credit Score
If you have no credit history, start out with a low credit line or a low balance secured credit cardA credit card that is secured against loss by other assets (often by money placed in a savings account with the credit card company). (see the previous section in Credit Cards). The secured credit card reflects all transactions recorded and reported to the credit bureaus to slowly build up a credit history. As you demonstrate your ability to make on time payments, your credit score will improve.
Other steps you can take to build your credit history and score include:
- open a savings accountAn account at a financial institution that earns interest and allows regular deposits and withdrawals. The minimum required deposit, fees charged, and interest rate paid vary among providers. or join a credit unionNot-for-profit cooperative of members with some common bond who, in effect, save their money together and make low-cost loans to each other. A financial institution. ,
- maintain a checking accountAn account that allows the customer to write checks on the money in the account. with no overdrafts,
- obtain a bank loan secured by the funds on depositA sum of money placed in an account in a financial institution. Also a sum payable as a first installment on a time-payment purchase or as a pledge for a contract. or cosigned by a family member,
- order cell phone or Internet service in your own name,
- always pay your bills on time!
Improving Your Credit Score
First investigate and make sure your credit history is accurate on your credit report. If you catch any inaccuracies, you can dispute them by sending a letter to the Credit Bureau. After that, the most important factor to improving your score is giving yourself the opportunity to make on time payments on good debt over time (see the section on Debt to better understand this concept). Good debt includes secured credit or a secured loanA loan which is backed by the borrower’s assets, when the borrower’s credit rating is not strong enough to justify an unsecured loan (not backed by the borrower’s assets). The assets may be forfeited to the lender if the borrower fails to make the necessary payments. like your home mortgage or car loan, and to some extent student loans. Having unsecured debt can also be turned into a positive credit score factor as well. For example, making credit card payments on time will also help raise your credit score.
Another key point to improving your credit score includes paying down your credit card debt so that the balance you owe is less than 30% of the credit line available to you. This 30% number is your credit utilization ratio. It means if you have $1000 available to spend on your credit card, try to keep your balance at no more than $300 at any given time. Of course, having no balance (paying the amount owed as soon as you receive your bill), is a good way to ensure you never use more than 30%, and your on-time payments will improve your score too.
Tips for Maintaining a Good Score
In general, avoid closing old accounts such as credit cards unless they have onerous rates or fees. Your length of credit history is important. Even if you don’t use it often, some activity is warranted on an old account. Buy a small item like pair of socks once in a while to keep that long standing account active and remember to pay it off on time.
Opening new accounts can also reflect well on your score, but only if opened responsibly and in moderation. Too many new accounts will lower your average account age, which will have a negative cumulative effect on your credit score.
Credit inquiries, (when a lender requests a copy of your credit history), can have a negative impact on your score. However, there is a simple strategy for minimizing any negative impact. When shopping around for a new loan or credit card, do so within a short window of time (14 days) as all credit inquiries within that window will only be considered as one negative cumulative “hit” on your credit score.