The Ins and Outs of Credit Scores
By Melinda Opperman, Senior Vice President, Springboard Nonprofit Consumer Credit Management, Inc. Campaign Coordinator, Inland Empire Saves
Your credit report serves as a kind of summary of your financial reputation. Its basic function is to tell lenders if you’ve done a good job of paying your debts on time and meeting your financial obligations.
A credit score is derived from information in your credit report. Your credit report reflects how you have handled your available credit in your past, and your credit score predicts how likely you are to pay your bills in the future based on information in your credit report.
Fair, Isaac, and Company, or FICO for short, is the company most well known for credit scoring and came up with a system to create a numerical score based on certain factors in your credit report. You have three credit scores, one from each national credit bureau: Equifax, TransUnion and Experian.
Your credit score may be different from each of the three national credit bureaus because the score only considers the data in your credit report at that particular agency. If your score from the credit reporting agencies is different, it’s probably because the information those agencies have on you differs.
The algorithm in the computer model generates a score ranking from 300 (not good) to 850 (exceptionally good). FICO has tuned its algorithm to give out a mortgage score, an auto score, a bankcard score, and so on.. Additionally, your score in any of these categories will be different depending on which bureau originated it.
We created a “What is a Good Credit Score?” infographic that breaks down what those numbers mean. Basically, a score over 680 is the threshold for “good” credit, but the higher your score, the better.
What factors into your credit score:
- 35 percent Payment history – more late payments will lower your score.
- 30 percent Amounts owed – if your balances are maxed out, your score will suffer.
- 15 percent Length of Credit history – the longer you have credit, the better for your score.
- 10 percent Inquiries – applying for new credit or loans hurts your score temporarily, it reflects your interest in or propensity for getting new credit.
- 10 percent Types of credit used - reflects the mix of your credit accounts and how you manage different kinds of credit (credit cards, auto loan, installment loan, home loan).
Tips for building a good credit score:
- Make your payments on time and in full. Your payment history is 35 percent of your score, and measures how you have paid in the past, and the equation includes both positive and negative information. You gain points for not having missed any payments and lose them if you have missed. If you’ve missed payments, get current and stay current. The weighting of late payments of the 30, 60, and 90 - day type are strongly influenced by the item’s severity, frequency and how recent. As derogatory information “seasons out” (i.e. 2 years) and you begin to utilize “revolving” credit responsibly you can improve a negative score.
- Amounts owed. This part of your credit score is called utilization and equals 30 percent of your score. Amounts owed are measured against the credit limit. If you just made a big purchase on your card, and your payment hasn’t yet been reported to the credit bureau (by your financial institution), the higher balance measured to your credit limit may lower your score. A lender may consider you to be higher risk when your balances are high.
- Don’t close your oldest credit card account —keeping it helps your “length of credit history.” Older accounts kept open with occasional use each year help retain valuable credit history and may help your score.
- Check your report for errors; mistakes on your credit report affect your score, but they can be corrected.
That last point is an important one; 1 in 4 credit reports have errors serious enough to affect the creditworthiness of the subject of the report. Our free Consumer Guide to Good Credit has more information about disputing inaccurate or outdated information on a credit report.
Finally, active duty military personnel can get free credit scores through their nearest PFMP (Personal Financial Management Program) office. And for taking the Military Saves Pledge, servicemembers and military spouses can obtain a FREE myFICO credit score and analysis tool from FINRA Investor Education Foundation and SaveAndInvest.org. Lastly, everyone can get free credit reports from www.annualcreditreport.com.