How Credit Scores are Determined
Perhaps the most important determinant when applying for any form of credit is your credit score. This number is essentially the statistical probability that you will pay back your loan and not default. The problem with these scores is that the intrinsics of their calculations are shrouded in mystery. Although you can obtain your score for a reasonable fee ($15.95 from Equifax.com), it’s important that you know how your credit score became the level that it is today – be that good, bad, or neutral – so that you can continuously work to improve your score, and never damage it by accident.
As a disclaimer, the exact formulas that each independent credit score company uses are considered to be trade secrets, so they aren’t disclosed to the public. What we do know is the weighting that was given to the original FICO score. From here, we are going to go through each category and explain a little of how that weighting affects you.
Punctuality (35%)
As is logically expected, the bulk of a score used to determine the probability of default is the punctuality of payment. The more punctual you are at making your payments (even minimum ones), the higher your score will be. Due to the high percentage, a late payment could substantially damage your score, and many late payments are certain to make you very non-creditworthy. The moral of this story is to make your payments on time.
Amount of Debt (30%)
The amount of debt that you owe, relative to the credit limits you have been given, affects this score. Using a large portion of your limits on one or more cards can damage your score. The logic behind this is that if you’re using a high portion of the limits that have been already given to you, adding new credit is more likely to make you default because you will likely use a substantial amount of it as well. So, keep the balance as low as possible relative to your limits. One trick is to try to use multiple cards to keep this ratio as low as possible.
Length of Credit History (15%)
This one’s very straightforward. Statistically, the length you’ve had a credit history means that the models are more likely to be accurate, so they’ve baked in some “accuracy” points here.
Types of Credit Used (10%)
It is not known how this is calculated. I would suspect that safer loans (such as, perhaps, revolving credit) don’t boost this portion much, but that successfully paying off larger, higher percentage loans – such as a mortgage or business loan – might help your score a bit.
Recent Credit Search (10%)
Lenders, employers, or companies recently obtaining your credit score damages your FICO number temporarily. You want to use aggregate services, such as mortgage brokers or web sites that compare rates, as much as possible and try to minimize the number of times you apply for credit. This is an easy way to boost your score.
Final Thoughts
In conclusion, take the time to examine some of the points above as they will give you solid tips into improving your score. Simple things like making your payments on time, or minimizing the number of credit applications you make will go a long way to making your credit score better than you ever thought it could be!
Source: http://en.wikipedia.org/wiki/Credit_score_(United_States)
Thu, Apr 9, 2009
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