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Credit Scoring made simple
It's your right to know what credit scoring agencies are saying about
you. Finding out this information doesn't cost a lot and takes only
minutes to do - which may be time very well spent.
So what is credit scoring?
Simply put, credit scoring is a method of assessing the credit risk of a
loan applicant. It uses mathematical models to evaluate a person's
credit worthiness based on their credit history and current credit
accounts. The system was first developed in the 1950s, but has come into
widespread use in just the last couple of decades.
In the early '80s, the three major credit bureaus (Experian, Equifax and
Trans Union) each developed scoring models that allowed them to offer a
score based solely on the data of one individual. Creditors, especially
those in the home mortgage industry, frequently use these scores when
deciding who gets a loan and at what rate. However, it's worth
remembering that creditors also consider other information, such as your
salary or employment history, when making loan decisions.
What's in a score?
Credit scores are reported as a number, usually in the 300-900 range.
The higher the number the better the score. Creditors see the number as
an indicator that an individual will repay a loan. Typically, scores are
determined by reviewing the following data:
- Your history of late payments
- Non payments
- Current level of debt
- Types of credit accounts
- Length of credit history
- Number of credit inquiries
- History of applying for credit
- Bad credit behavior, such as writing bad checks
Personal details such as race, gender and religion are definitely not
considered when determining your score. It's also worth noting that each
major credit bureau has its own method for calculating credit scores.
However, the scoring models have been fairly well standardized so that a
"600" score at one bureau is roughly the equivalent to the
same score at another.
What's a good score?
Overall, a score of 650 or above is a sign of very good credit, and a
very good credit score. People with scores of 650 or higher will, all
things considered, have a good chance of obtaining quality loans at the
best interest rates.
Scores of 620 to 650 indicate good credit, but also may point to
potential trouble areas that creditors will want to look at and review.
A lender may require additional documentation before a loan will be
approved.
With scores of below 620, consumers may find that they can still obtain
a loan. However, the process will be lengthier and more involved, as
creditors consider scores below this threshold to be an indicator of
greater credit risk. |
What goes in your score?
Behind the numbers
So you've got your credit score report. What numbers do they crunch to
come up with it? Where's it all coming from? It's really not all that
hard to understand, and learning more about what factors influence your
individual number can help you improve your credit score in the years to
come.
Knowing the Players
Three major credit bureaus, Experian, Equifax and Trans Union, calculate
consumer credit scores. Each company has developed statistical models
allowing them to determine scores based on your own individual credit
history.
About thirty individual factors are used to determine your score.
Certain factors, such as loan payment history, may carry more weight
than other parts of your credit history. Indeed, it's important to
remember that each person is different. A factor that may be important
to your score might be less important for someone else because of
differences in your credit past. Also, each factor's importance can
change as your credit report changes and has new information added to
it.
Percentage Breakdowns
There are five broad areas that credit bureaus look at:
- Payment History- Details about credit cards, installment loans
(such as a car loan), mortgage loans or finance company accounts are
considered. Wonder how that late or missed payment affects you?
Well, it shows up in this part of your score, which accounts for
about 30% of the total.
- Outstanding Debt- Total amount owed and the ratio of what's owed
to your credit limit is factored in for another 30%.
- Credit History- How long have you been building a credit history?
How long have specific accounts have been established and how long
have you used each account? On average, this category determines
about 20% of your score.
- Pursuit of New Credit- Applications for credit and the status of
new accounts, including a determination of how recent your accounts
are, are looked at for another 10%.
- Types of Credit In Use- The numbers of accounts and the different
types of accounts, such as bank cards, department store cards, and
installment loans are all considered. This category usually rates
another 10% of your final credit score.
Scoring Higher
Knowing your credit score is important. Perhaps even more important,
however, are the reasons detailed in your score report about why your
score isn't higher than it is. Possible reasons for lower scores may
include:
- Too much debt on existing accounts
- Past delinquency on accounts
- Too many accounts opened in the last twelve months
- Collection history
- Excessive number of accounts with balances owed
- No recent account history
These are action items that you as a consumer can have an effect on.
Your credit report changes day to day as you make payments or increase
balances. For example, if you pay off your credit cards in full every
month and maintain a responsible credit history, your score will
gradually start to reflect those balances. |
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