The most commonly used credit score is the Fair Isaac Corp. score, or the FICO score. The score runs from 300 to 850. A score above 750 is generally considered good and a score below 620 is considered risky. The range between the two depends on the lender looking at the score. FICO uses information from your credit report, which is compiled by three major credit reporting agencies, to calculate your credit score.
Credit scores are only part of the information that lenders look at when making a lending decision and a low score is not necessarily a fatal blow. Each lender has its own strategy and level of risk and each has its own cut-off point below which it will not extend credit at any price. But knowing the hows and whys of credit scoring is essential to anyone thinking about a purchase money mortgage, a refinance, or a home equity loan in the near future.
Lenders typically buy credit reports from one or more of three national credit reporting companies; Equifax, Experian, and TransUnion. More and more, however, lenders are also buying FICO scores produced by these companies. These scores are a mathematical evaluation computed from information about an individual borrower already on file with that credit bureau which is compared with patterns distilled from hundreds of thousands of other credit reports.
Breakdown of the FICO Score:
- Payment history: Makes up of 35% of the FICO score. FICO scores weigh recent credit history more heavily than credit actions that took place in the distant past.
- The amount of debt: Makes up of 30% of the total score. It is best to keep the ratio of credit card balances compared to approved credit limits as low as possible. Keeping a balance on several credit accounts is not a concern. However, it is if you owe a great deal of money.
- Length of credit history: Makes up of 15% of the FICO score component. As a general rule of thumb, it is better if the borrower has a longer history as a credit user if they also have a history of making timely payments.
- Very recent credit history: Makes up of 10% of the total score. Many recent attempts to open new accounts will lower your score.
- Analysis of a borrower’s credit: Makes up of 10% of their FICO score. The score reached from this component comes from the mix of credit that the borrower holds such as installment loans (car loans), leases, mortgage, credit cards, and other forms of credit.
How can I increase my score? While it is difficult to increase your score over the short run, here are some tips to increase your score over a period of time:
- Pay your bills on time. Late payments and collections can have a serious impact on your score.
- Do not apply for credit frequently. Having a large number of inquiries on your credit report can worsen your score.
- Reduce your credit-card balances. If you are “maxed” out on your credit cards, this will affect your credit score negatively.
- If you have limited credit, obtain additional credit. Not having sufficient credit can negatively impact your score.
The key is to get credit only when you need it (unless you’re trying to establish your first credit), and then use it carefully, make your payments on time, and keep your balances low. Remember not to max-out credit cards.
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