Have you ever wondered how some lenders determine whether to give you credit or not? Creditors have been using a credit scoring system for years to determine whether or not you would be a good risk for an auto loan, a mortgage, credit cards, and sometimes even a job. In many situations, a credit score is used to determine whether you should be issued an insurance policy or how much, if anything you may have to pay for a deposit on household utilities. The higher your credit score is, the less you may be of a risk, which in turn means the more likely you are to get credit or pay less for the credit.
What is Credit?
There is a difference between credit and credit scoring. Credit is referring to borrowing; the ability to borrow as well as the amount you borrow. As a borrower, your credit is your reputation when it comes to loans, such as auto loans, credit cards and/or home loans. Your credit score basically tells lenders how likely you are to repay loans, which will help them to decide whether or not to approve a loan request and how much to charge you. Your credit is basically the information about your borrowing history and the majority of this information is provided to lenders from your credit reports.
What is a Credit Report?
A credit report is the collection of information about your credit. Lenders base their decision whether to offer you a loan or not, based on this information. In most situations, a lender will not actually look at all of this information; they will simply look at your credit score. The credit reports are what determine your credit score. Credit reports typically include:
• Your previous loans including those that have been paid off
• Your current loans including all of your unused lines of credit
• The amount you have borrowed
• The required minimum monthly payments
• Your payment history; for example if you have made late payments or if payments were always on time
• Public records, such as a foreclosure and/or a bankruptcy
• Any loans that you have defaulted on, including those that are in collections
Who Keeps Track of Credit Scores?
As a consumer, you have three FICO scores, one from each major credit bureau; TransUnion, Equifax and Experian. The credit bureaus use an algorithm to determine what your credit score is; based on the information provided to them from your lenders. Lenders use your 3-digit score provided by the credit bureaus to help determine if they will approve you for a credit card or a loan. The higher your score is, the better the chances are that you will be approved. A high credit score can also help you to save on interest rates.
FICO scores range from 300 to 850:
• Excellent credit is typically 750 and higher
• Good credit is 700-749
• Fair credit is 650-699
• Poor credit is 600-649
• Bad credit is typically anything below 600
What Affects a Credit Score?
Your demographic or personal information, such as martial status, age, income, race, address and/or employment do not affect your score. A FICO score is made up from five major categories in your credit report:
• Payment history-35 percent of a FICO score. This is your account payment information, including any public records and/or delinquencies.
• Amounts owed-30 percent of a FICO score. This is the amount you owe on your accounts. The amount of available credit you are using on revolving accounts has a significant impact on this portion of the score.
• Credit history length-15 percent of your FICO score is based on how long ago you opened accounts and the amount of time since there has been account activity.
• Type of credit used-this accounts for 10 percent of your score and is based on the mix of accounts, such as revolving accounts and installment accounts.
• New credit-10 percent of your score is based on credit inquires and the number of recently opened accounts.The above percentages total 100%, which basically means in order to build a good credit score, you will need to make all of your payments on time, try to stay below at 30% on the amount of debt you own and add a mix of accounts over time and use caution on how often you apply for new credit in a short period of time.
The above percentages total 100%, which basically means in order to build a good credit score, you will need to make all of your payments on time, try to stay below at 30% on the amount of debt you own and add a mix of accounts over time and use caution on how often you apply for new credit in a short period of time.
How Can You Improve Your Credit Score?
The systems used for credit scoring are quite complex and they vary among creditors. If just one factor changes, your credit score may change; however, improving a credit score typically depends on how one factor relates to another. Fortunately, there are a few things you can do now to improve your credit rating without having to worry about algorithms or percentages:
• Check your credit report-the most important thing you can to do repair and/or improve your credit score is to know what you are dealing with. It is essential that you carefully check for any errors, such as payments incorrectly listed as late or accounts that you do not or did not have. If you find any errors on your credit report, it is critical that you dispute them with the credit bureau.
• Pay all of your bills on time-keep in mind that delinquent payments, even if they are a couple of days late, can have a negative impact on your credit score.
• Paying a collection account-it is important to understand that if you pay off a collection account, it will not be removed from your account, it will stay there for seven years.
• Missed payments-if you have missed payments, get caught up as soon as possible and stay caught up; the longer you pay on time after being late or missing payments, the more your FICO scores will increase.
• Reduce your debt-this is one of the most difficult parts of raising your credit score. However, reducing the amount of debt that you owe, will not only improve your credit score, but it is also a satisfying accomplishment. Create a realistic budget by figuring up all of your bills and use your salary to determine an amount that you can honestly afford to pay and stick to this amount no matter what…unless you get to a point where you can afford to pay more, but never pay less.
You need good credit in order to qualify for a mortgage, a car loan and possibly even employment. But, it is extremely important to keep in mind that fixing your credit score takes time. It is essential that you do not take on any new debts until you pay off the current ones and only then if you are positive your credit score can accommodate the new line of credit.