Understanding the credit score rating system is of the essence for anyone who uses or wishes to establish or restore credit. And you don’t have to know all the intricacies that go into calculating your score; just the basics will do.
The basics of the credit scoring system are not that difficult to understand. This information used to be a closely guarded secret until an act of congress forced Fair Isaac, the creator of the most used credit scoring model, to disclose it. Previously, consumers were forced to fly in the dark, as it were, on something that has such a great impact on their lives.
Defined in simple terms, your credit score is a three digit number that indicates your creditworthiness. Needless to say, a lower score indicates bad risk and a high score indicates good risk.
The patriarch of credit scores is the FICO score as it is the one that most creditors use. And though you typically will get this score when you apply for credit, not all credit bureaus supply it directly to consumers. Only two companies can supply you the real FICO credit score.
The FICO score was created by Fair Isaac Corporation and as you might have guessed, the name FICO is actually an acronym of its creator. It is a number between 300 and 850.
There are pretty few people on either extreme of the score. Most people fall somewhere in between. And it is okay to attempt to attain the perfect score, 850, but it is not all that important and could live skor cause you unnecessary stress. What really matters is the range you are in.
A score of between 720 and the maximum 850 used to be considered prime. But after the mortgage meltdown that started somewhere in 2007 and the ensuing credit crisis the bar was raised. You now need a score of at least 740 to 750 (depending on who’s looking) to be considered for the best interest rates in loans, credit cards and other forms of credit.
How is your credit score calculated?
Most of the details of the credit score rating system are still closely guarded secrets. But the basics, which suffice for the average consumer, are as follows:
- Your payment history accounts for 35% of your score: A good payment history over a lengthy period of time is what counts here.
- You debt to credit ratio accounts for 30%: Maxing out on your revolving credit (such as credit cards) is not a good thing. Fair Isaac considers what you owe on each account as well as in total.
- Length of your credit history (15%): The longer your history, the better. This is the reason you should start building credit as early as possible, even after a bankruptcy.
- Variety of accounts (10%): A “healthy mix” of types of credit is desired. Also, riskier types of credit such as credit cards often score lower than mortgages, car and school loans.
- Number and of accounts (10%): Too few credit accounts can hurt your score as can too many. Applying for new credit frequently can hurt your FICO credit score as it indicates risk (you appear desperate).
You should also be aware that your credit rating will differ with each bureau. This is mainly because different creditors report to different bureaus and therefore each bureau’s data can differ from one of or both the twos’.
As if to add more confusion to the whole credit score rating system, each major credit reporting bureau refers its score by a different name. Equifax calls theirs the BEACON score, Transunion calls it the FICO Risk Score and Experian calls it FICO II.