Your credit score is one of the most important decision-making factors that lenders use when they are considering you for a loan. The loan may be for a new home or new car or it could be a very small personal cash loan. Your credit score is used in almost all of these decisions, regardless of the size of the loan or the nature of the loan. For this reason, it is imperative that you understand what your score is and how it got to be that way.
Formulating a credit score can vary from one country to another. In the United States, a credit score is a number that is based on a somewhat complicated statistical analysis of a person's credit report. The credit score is used to represent the creditworthiness of that person. In other words, can the lender trust you to pay back the loan?
For the most part, your credit score is primarily based on credit report information that has been supplied through the three major credit bureaus. Keep in mind that your credit score is just one number that is derived through the information sent from the credit bureaus.
Banks, mortgage lenders, credit card companies and other types of lenders use the credit score to evaluate your credit history. They want to know if you are a good risk or a bad credit risk. The credit score is just one factor that they use when deciding if they will give you a loan or not, but it is an important factor because it also is used to help the interest rate that will charged, the credit limit, and other issues concerned with the loan.
The most widely known score in the United States is FICO. This is also the most widely used in the home mortgage industry. There are many other credit score systems as well, such as NextGen, VantageScore, and the CE Score.
The exact formulas for calculating credit scores are closely held secrets, but the Fair Isaac Corporation has revealed that the following components are normally used and given the approximate value:
35 per cent punctuality of payment in the past (only includes payments later than 30 days past due).
30 per cent the amount of debt, expressed as the ratio of current revolving debt (credit card balances, etc.) to total available revolving credit (credit limits).
15 per cent length of credit history.
10 per cent types of credit used (installment, revolving, consumer finance).
10 per cent recent search for credit and/or amount of credit obtained recently.
You may not know this, but because of the Fair and Accurate Credit Transactions Act (FACT ACT), each legal U.S. resident is entitled to one free copy of his or her credit report from each credit reporting agency once every twelve months.
If you wish to keep track of your credit information more frequently than yearly, you can request a report from a different credit reporting agency every four months. Keep in mind that the free report does not contain a credit score. You can buy a credit score if you wish but do understand that requesting a credit report will subject you to pre-screened offers of credit cards. To prevent all three credit bureaus from making your address available to credit card companies for this purpose, you may opt out by calling 1-888-567-8688.
Many consumers know that they have a credit score but they may not know what the score is. As well, many consumers know that there are some actions or inactions that they can take that will help or hurt their score. Again, they know the broad picture, but not the details. Here are some of the things that consumers do that all but massacres their credit score.
First of all, consumers should understand that lenders and creditors are constantly updating the information that is on a person's credit report. This is one of the most important reasons why consumers must keep an eye out for mistakes or omissions on their reports. Credit reports are not static.
Some actions or inactions that can kill a credit score follow:
Not examining credit reports often enough is one of the most common problems that consumers face. These reports are used to determine your credit score. If there are mistakes, you need to get them corrected. The truth is one in four credit reports contain errors that are serious enough to hurt a consumer's chances of getting loan.
FICO credit scores are calculated from five categories listed on credit reports: your payment history, amount of money owed, length of credit history, new credit obtained, and types of credit used.
The second thing many consumers do to hurt themselves is to pay late. Late payments are recorded on your report and they usually stay there for seven years. In general, payment history accounts for 35 percent of the credit score.
The third thing that can cause problems is simply having too many credit inquiries. A credit inquiry occurs whenever someone wants to look at your credit file.
Rate shopping for a car loan, a home mortgage, or a credit card can damage your credit if it is not done properly. Lenders you approach ask credit bureaus for a copy of your report for review. This request shows up on the credit report as a hard inquiry, which affects your credit score.
Minimize the potential damage by rate shopping within a short period of time, such as a couple of weeks. According to myfico.com, "Multiple inquiries from auto or mortgage lenders in a short period of time are typically seen as one inquiry and have little impact on your score."
Believe it or not, closing your old accounts can damage your score because, in essence, doing so may shorten your credit history. Credit history makes up about 15 percent of the score, so you do not want to shorten it unless it is absolutely necessary.
Closing accounts will also affect what is called the credit utilization ratio. This is the amount of credit you are using relative to the amount of available credit you have. Closing an account will cause your ratio to go up because closing the account drops your total available credit while not reducing the amount of credit you are using.
Consumers should be very aware of the amount of debt that they have on the books. Amounts owed will make up nearly 30 percent of the score. The more you owe, the lower your score will be.
Lastly, consumers should be careful about cosigning for another person. If the other person does not pay on time you will most likely see a reduction in your credit score.
Keep track of what is on your credit reports and you will have done a lot to maximize your credit score.
Peter Kenny has sinced written about articles on various topics from Credit Cards, Finances and Best Money Market. Peter Kenny is a writer for The Thrifty Scot, please visit us at and. Peter Kenny's top article generates over 368000 views. to your Favourites.