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What Exactly is a Credit Score?
Your credit score…that mysterious number that most people know so little about, plays a very big part in shaping your financial future. A high score can open many windows of opportunity, while a low score can make even small purchases difficult. OnlineCreditMagic.com knows a thing or two about credit and we believe that educating you about the ins and outs of credit, will make you a better customer. So lets start with the very basics.
Credit scoring was first developed in the 1950’s by Fair Isaac & Co. Credit as a means of standardizing the process of determining a consumer’s credit worthiness. Basically, it seeks to condense your entire credit history into a single 3-digit number that tells prospective lenders how likely it is that you will pay them back.
The score, referred to as your FICO score, after the company that developed it, is arrived at by assigning points to different portions of your credit history and measuring them against statistical averages of how millions of other consumers have used credit. While there are always exceptions to the rules, the scoring model has proven to indicate future credit performance.
Each bureau has developed their own version of the FICO score, using common methodology, but because they are private companies that do not share information, each score will vary slightly from the others. Each bureau also has their own unique name for their credit scores:
For Equifax, it is called the Beacon Score
For Experian, it is called the FICO Score
For Trans Union, it is called the Empirica Score
In 2006, seeking to make credit scoring more consistent, the three major credit-reporting agencies introduced VantageScore, which uses letter grades based on a number range from 501 to 990. Although the methodology for determining the score is identical, your VantageScore my still differ from bureau to bureau, based on what information each of them knows about your history. Since FICO remains the most widely-used score by creditors, the major credit bureaus will continue offering FICO scores indefinitely.
5 Main Factors Determine Your Credit Score:
Your Payment History (35% of your score) - This factor has the largest impact on your score. The timeliness of your payments has a significant role in your ranking, however, a long-term favorable credit picture can outweigh a few late payments, and those late payments have less of a negative impact over time. That is unless the late payment is a mortgage payment.
Amount You Owe (30%) - Having debt doesn't mean you're a high-risk borrower. However, a pattern of owing a significant amount of money on a number of accounts may suggest that you are fiscally overextended and more likely to pay late or worse, not at all. It is a subjective process to determine just how much debt is too much for a given individual.
How Long is Your Credit History (15%) - Basically, a longer credit history will have a positive effect on your FICO score. It demonstrates that you can manage your finances over time. However, even people who don’t have much of a credit history may get high scores, depending on the rest of their credit picture.
Opening New Credit (10%) - Opening several credit accounts over a short period of time can send up a red flag - especially for those with short credit histories. Multiple requests for new credit can also send a negative signal. However, FICO scores are able to distinguish between a surge in opening new credit accounts and simply shopping for a better financing rate. FICO scores generally do not penalize against rate shoppers.
Types of Debt (10%) - Your FICO score reflects a combination of all the types of debt you hold, including credit cards, retail accounts, finance company accounts, installment loans and mortgages. A healthy credit mix will improve your score, however, it is not necessary to have one of each. Also, don’t open credit accounts you have no intention of using. The credit mix usually isn't a key factor in determining your score, but it can have an effect if your credit report doesn't contain much other information.
Limited Personal Information
Believe it or not, much of your personal financial information IS NOT INCLUDED in your credit score.
- Your current income and bank balance aren't included on your credit report, so they cannot be part of your credit score. Only information that is on your report can determine your credit score.
- The interest rates you pay are not on your credit report, so they are not part of your score, however, certain kinds of loans that require you to put up a large collateral may suggest that you are having financial difficulties and can lower your score.
- Your occupation, job title, employer, time with the company, and employment history do not affect your credit score. Although they may appear on the report, very often, the information is incomplete.
Range of Scores
Scores can range from a low of 300 to a maximum of 850. According to Fair Isaac & Co., the median credit score is 723, however Experian reports the median score is 678. Generally speaking, a “Prime” or “A-Class” borrower ranks above 700. They have an excellent credit history and are able to obtain more credit quickly and easily with more favorable terms. “Alt-A” borrowers fall between 620 and 700, and typically have good chances at obtaining credit based on a good credit history, but further assessment of that history is recommended to the lender before approving a large loan or a higher credit limit. A “Sub-Prime” borrower has a score below 620. Various reasons can cause a low score, which can exclude a borrower from enjoying favorable terms and lower interest rates because they are a greater credit risk. However, it doesn’t necessarily mean that credit won’t be granted, but the process will take longer and the terms won’t be as good.
The Equal Credit Opportunity Act prohibits basing credit decisions on race, ethnic group, religion, gender, marital status, or national origin. You cannot be rated based on the neighborhood live in. Age is not a factor because lenders are prohibited from discriminating against the elderly.
Know Your Credit Score
Financial experts agree that regularly checking your credit report is critical to maintaining a healthy credit score. You will be made aware of who is checking your credit history and how often they are doing it. You will be able to respond quickly to an inaccuracy or fraudulent entry before it has time to extensively damage your score.
Did you know that you are entitled to one free credit report per year? It is possible to obtain your “free” credit report directly from the 3 credit bureaus, however, they require you to subscribe to a paid service on a free trial basis, that runs out in 30 days. If you forget to cancel the service, you will be charged the subscription fee. The following websites provide easy methods of getting your report online, completely free of charge.
IMPORTANT: You are entitled to one free credit REPORT per year, which is very informative and helpful in examining your credit record and seeing what the creditors see when they run an inquiry, however, your REPORT does NOT contain your credit score. You will have to pay a small amount ($6-$8) to receive your credit score along with your report.