Understanding Your Credit ScoreBy Michael Hawthorne
Credit scoring systems turn the raw data found on credit reports into a number that measures creditworthiness, or in other words, the likelihood that an individual will be able to pay back a loan. When people talk about a "credit score," 99% of the time they are talking about the "FICO" credit score. FICO is an acronym based on the names of the mathematicians who created the scoring algorithm and the company (Fair Isaac - now called "FICO") they subsequently founded. FICO gives the following guidelines on the weight of different factors in your FICO credit score:
Payment History - 35%
Amounts Owed - 30%
Length of Credit History - 15%
New Credit - 10%
Types of Credit Used - 10%
While this list is a bit general it gives you a good idea about the factors involved in your credit score. Not surprisingly, financial institutions are most concerned about your past payment history when deciding to extend you a new loan. If you have a history of taking out loans and paying them back in a timely fashion, your chances of getting more credit are greatly improved. On the other hand, if you have a history of missed payments, collections and bankruptcy, your credit score will suffer.
Credit Score Tips
While the credit rating agencies only give us general guidance about credit scores, there are several accepted norms you can use to help keep your credit score healthy:
- Pay your bills on time.
- Using all of your available credit can have a negative impact on your credit score. The anecdotal rule of thumb suggests using no more than 20-30% of your available credit.
- The longer a credit account is open and in good standing the greater the positive effect on your credit. Takeaway: if you have a credit card that's been open for years, you shouldn't close the account (even if you aren't using it) unless it carries regular fees.
- Voluntary inquiries can have a small short term (1-6 months is a rough guide) negative effect on your credit. The credit agency Fair Isaac reports a single voluntary inquiry affects most credit scores by less than 5 points. However, several simultaneous inquiries can add up and are viewed suspiciously by the scoring algorithms. There is an exception to the multiple inquiry penalty: all mortgage and auto loan rates inquiries within a 45 day window will be counted as a single voluntary inquiry.
- It takes approximately 7 years for missed payments and other negative loan information to roll off your credit report and stop affecting your credit score. The good news is that as the 7 year period progresses the negative effect does diminish.
Get Your Credit Score
There are three major credit bureaus: Transunion®, Equifax® and Experian®. Each bureau maintains their own credit reports and FICO scores. Individual credit report information and FICO scores can vary from bureau to bureau though, unless one bureau has an error in it's reports, both should be substantially similar from one company to the next.