You’ve heard about credit scores and know that they are considered important, but why should you care about your credit score? Your credit score is looked at for multiple reasons - sometimes by employers, landlords, your credit union, but also anytime you apply for a loan, including a home loan. Understanding credit scores and how they’re calculated will help you check into and improve your own score so you can have better credit when you are ready to apply for a new loan.
How a Credit Score is Calculated
The most common credit score used is called your “FICO™” score, standing for Fair Isaac Corporation. FICO™ scores were first used with lenders in 1989. This score can affect how much a lender will loan you and at what interest rate. The score is calculated using information contained in your credit reports with each of the three main reporting agencies.
While the exact formula is unknown, we do know that FICO™ scores are calculated by considering five different categories. The importance of each varies as well as the factors within every category:
Payment History - Weight: 35%
Have you paid past credit accounts on time? How many accounts have late or missed payments?
Amounts Owed - Weight: 30%
How much do you owe on your credit accounts and how many accounts do you have? How much of your total available credit are you currently using?
Length of Credit History - Weight: 15%
How long have your credit accounts been established? How long has it been since you last used some of those accounts?
Credit Mix in Use - Weight: 10%
What types of credit accounts do you have? How many different types of credit accounts are you using?
New Credit - Weight: 10%
How many new accounts or recent inquiries do you have? How long has it been since you opened a new account?
These are general guidelines of what is considered and can vary from person to person according to what information is contained in their credit profile.
Credit Score Ranges
Base FICO™ scores range from 300-850. Lenders have different definitions of what range of scores are considered “good” or what scores will receive better programs and rates. In general though, this range represents what the different scores mean:
800 +: Exceptional
740-799: Very Good
< 580 : Poor
Even if your credit score is not in the good or higher range, there are still loan programs that you may qualify for.
Positively Impact Your Credit Score
Once you understand how your credit score is calculated, there are things you can do to improve your score. Here are some easy ways to make a positive impact:
- Make all payments on time. Set reminders or have payments made automatically.
- Create some balance in how you reduce your debt. While paying down installment debt (car, school, mortgage, etc.) will definitely boost your credit score, paying down or paying off revolving debt, such as credit cards, can cause a quick jump in your credit score. The trick is to get and keep your balances below 30% of your credit limit on each card. For faster results, attack those cards with balances closer to their respective credit limits first, as opposed to those cards with the highest debt.
- Check for errors. Get a free copy of your credit report and look it over carefully.
Avoid Negatively Impacting Your Credit Score
- Keep your credit score healthy and ready for that upcoming home purchase by avoiding anything that negatively impacts your credit score.
- Avoid opening too many new accounts in a short amount of time. Let accounts have some aging time.
- Avoid moving debt around to multiple cards. Focus on reducing the amount instead.
- Do not close out a card. A sudden drop to your credit-spending power does not look good to the bureaus. You can keep it active by perhaps using it to pay a monthly utility bill.
- Avoid “quick-fix” credit solutions. Manage credit responsibly over time and your score will improve.
Now that you have an understanding of how your credit score is calculated, you can take steps to get your credit in better shape.
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