Credit score or credit scoring is a system creditors use to help determine whether to give you credit. It also may be used to help decide the terms you are offered or the rate you will pay for the loan.

 

When you apply for a car loan or mortgage, your lender will request a credit report from a credit reporting company. This is usually a local or regional company. This company pulls together a credit report electronically. It usually comes from one or more of the major repositories, but it can come from several sources.

 

Along with the information, the local credit reporting company receives a numerical score called a credit score. The score represents a composite of the borrower's credit history, employment, ability to save, and so on. The most popular of these scores is known as the FICO score, which was a model developed by the Fair-Isaac's Company a number of years ago.

 

FICO

 

Fair, Isaac and Co. is the San Rafael, California Company founded in 1956 by Bill Fair and Earl Isaac. They pioneered the field of credit scoring for financial companies. They have expanded their enterprise to cover decision systems, analytics and consulting. Every credit agency, and most lenders, calculates your credit score using software from FICO (Beacon) or in house software based on the FICO rating system.

 

What does your score mean?

 

Lenders use credit scores because they provide information on how customers performed on loan payments and helps predict how likely an individual is to repay a new loan. In order words the rating system is meant to develop a snapshot of the risk you currently represent to a lender. Several parameters in your credit file, including payment history, amounts owed, length of credit history, number of open accounts, type of credit used, public records, and others are formulated to produce a three-digit score between about 350 and 850. The higher the number, the better

 

What makes up your credit score

 

 

35% payment history: Looks at items such as late payments and bankruptcies, which can hurt your credit score. Having a long history making of payments on time on all types of credit accounts is one of the most important items lenders look for.

 

30% amounts owed: Considers your debt and your available credit lines. The more you owe compared to your credit limit, the lower your score will be. The key here is, do not max out all your credit limits. Your credit score can be lowered when you use more than 50 percent of your available credit for each account.

 

15% length of credit history: Checks how long you had your credit accounts and how often you use them. A longer credit history will usually increase your FICO ® score. Generally a credit report containing accounts opened for at least 10 years or more will help your credit score.

 

10% new credit: Looks at new credit accounts you opened and new credit requests (such as credit cards). Multiple credit requests also represent greater credit risk.

 

10% types of credit used: Considers how many credit accounts and how many installment-type accounts you have. A diverse credit portfolio can strengthen your report. Having a mixture of credit cards, retail accounts, finance company loans and mortgage loans is considered in boosting your score..

 

It's important to mention that lenders usually use a combination of your credit score with other factors when determining your risk. While there is no single number universally used by financial institutions, data on late payments indicates that people with FICO scores below 700 have a significantly higher rate of making late payments. For that reason lenders tend to charge people with scores lower then 700, higher interest rates and fees on their loans. How much more?, take a look at the cost of bad credit.

 

 

All lenders have the same objective, to determine the borrower’s potential risk. Regardless of whether the score was generated by FICO or a system based on FICO parameters, they all yield an industry standard three-digit score. This score places the borrower in one of three main categories.

 

Prime and Sub-Prime or Worse

 

Prime - If your credit score is above 680, you are considered a "prime borrower" and will have no problem getting a good interest rate on your home loan, car loan, or credit card.

 

Sub-Prime - If your credit score is below 680, you are considered a "sub prime borrower”, and will likely pay a higher interest rate on your loan.

 

Worse - If your credit score is below 560, you can still get a credit card but you will likely be hit with a security deposit or high acquisition fee. In addition to that your interest rate will likely be 22 to 23%. You can forget about most home loans and the majority of new car loans at this score.

 

Below 560 is no place to be. You will pay much, much more in higher interest and unnecessary fees. You may even pay more for your insurance rates. A very low score can even prevent you from getting a job with many companies.

 

Breakdown of your Risk Level

 

Low Risk (726 - 830)	Lenders rest easier when they extend loans and credit to individuals with high Credit Scores. Plus, you may be able to save money by negotiating a lower interest rate or a better term on a new loan or credit card.
Low - Medium Risk (700 - 725)	Lenders may be more willing to extend credit to individuals with Credit Scores in the low-to-medium risk range. In this range, you may get better-than-average rates and terms on new loans and credit cards.
Medium Risk (626 - 699)	Lenders may still be willing to extend loans and credit to individuals with mid-range Credit Scores; however, you may only get average rates and terms.
Medium - High Risk (551 - 625)	Lenders may be less willing to extend credit to individuals with Credit Scores in the medium-to-high risk range. In this range, you may not enjoy the best rates possible.
High Risk (330 - 550)	Lenders may be wary about extending loans and credit to individuals with Credit Scores in the high-risk range. You may be denied credit, or pay higher rates.

Source: Experian®

 

How is your credit score calculated

 

There is no simple answer to this question. Each bureau has its own way of calculating your credit score. They simply adapt your FICO score to their specifications. For that reason, credit scores reported by the credit bureaus are sometimes referred to as “Bureau Scores.”

 

One of the important things to know when you read the section, "How to Repair Bad Credit" is that because your score is derived from your bureau data, it will change every time your reports changes. There is not a single factor that determines your credit score. There are many categories that are taken into consideration when your score is calculated

 

Other factors that determine you credit-worthiness

 

It's worth mentioning that the lender, not a credit score, makes the final decision to approve or reject a loan or credit card application. A credit score is simply a tool used by the lender. The lender may take into consideration any special reasons for your past credit problems.

 

In addition to your credit score, lenders look at many things when making a credit decision, including your income, if you have an equity investment in a home, job history, savings, and the kind of credit for which you are applying before making a final decision.

 

 

Note:

Whenever you apply for credit or a loan, by signing the application form, you are giving the creditor permission to order your credit report from a credit-reporting agency. Here are some other credit facts you might need to know.

 

Do you know your FICO score? Your credit card company does, and they're using it to evaluate your every financial move.

Credit Score Basics

 

What's the buzz about FICO 08

 

 

 

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