Understanding Credit Scores

Credit Scores

A credit score is a “snapshot” of your creditworthiness at one point in time. Each time someone requests your score, the credit rater goes through three steps:

1 Collecting information from the three major credit reporting bureaus—Experian, TransUnion, and Equifax

2 Comparing your credit history to the credit history of consumers with similar profiles

3 Adding or subtracting points from your score for each item that makes you more or less likely to repay a debt Most people don’t realize that they usually have three scores at any one time — one for each credit bureau — and those scores can vary a lot because some creditors do not report to all three agencies.

FICO The Fair Isaac Corporation developed the FICO score, which is a measure of consumer credit risk. It provides lenders a score that helps them determine if lending to a particular consumer is a good idea. The FICO score is the most commonly used credit score. There are five categories that are considered in order to come up with your credit score:

1 Payment History - Do you pay your bills on time? Have you ever filed for bankruptcy?

2 Amounts Owed - How much do you currently owe? How many accounts do you have open? How close to the accounts’ maximum limits are you?

3 Length of Credit History - How long have you had a credit record on file?

4 New Credit - How many new accounts have you opened and/or applied for? Too many applications for or opening of new accounts may make credit companies wary.

5 Types of Credit Used - Credit backed by assets or equity are more favorable (mortgages and auto loans) than credit cards or store cards, which are seen as “spending” credit.

Actions that Affect Your Credit Score Three things that you should avoid doing in order to help keep your credit score higher:

1 Transferring a credit balance from one card to another - Even though credit card companies frequently offer 0% interest for you to transfer a balance, if you are transferring more than half your balance, this may hurt your score. Also, getting new cards may affect your score.

2 Closing credit accounts - Closing credit accounts usually damage your credit score because reducing the credit available to you increases your credit utilization ratio (see below for details). Also, closing an account you have had for a long time may affect your score negatively.

3 Not using credit cards - Avoiding using credit at all is not good because then you will have no credit history or track record of payments. Credit Utilization Rate The credit utilization rate compares your total debt to your available credit. Keeping this ratio below 50% helps keep your creditworthiness in good shape. Credit scoring models often consider your credit utilization rate when calculating a credit score for you. They can impact up to 30% of a credit score depending on the scoring model being used.