Credit Scoring: Know the Numbers
Credit Scoring: Know the Numbers
At some point in your life, you may want to make a big purchase,
such as a car, a boat, a house, or new furniture, and when the time comes,
you will need a good credit score.
What
is a Credit Score?
A credit score is a number applied to your credit record that indicates
the level of risk involved in doing business with you. Simply put, good
or bad credit is determined by credit scoring. A high score means good credit.
This 3-digit number affects the outcome of an application for the following:
a mortgage, a credit card, a car or school loan, as well as any other expensive
item you may want to purchase on credit.
When applying for a loan, the lender often uses an individual’s credit score to calculate the interest rate. If you have a low credit score, typically, you will have to pay a high interest rate. The lender perceives your credit score as a way of assessing whether or not you will honor your obligation and make payments on time. Landlords also do a credit check on a potential tenant before renting his premises. If you have a lot of debt, you might want to check out a debt consolidation guide site.
What Affects your Credit Score?
There are a number of factors that can affect your credit score,
which can range anywhere from 300 to 900 (the majority falls between 600
and 800). Here are the main factors impacting credit scoring:
• The number of debts you have: owing a lot of money will give you a low
credit score.
• How you pay your bills: whether or not you pay your bills on time.
• The span of your credit history: the longer your credit record, the higher
your score; therefore being responsible with your first credit card is important,
as hard as that may be for some teenagers!
• Prior credit problems: contact from a collection agency or declaration
of bankruptcy is a negative mark on your credit record.
• Various credit combinations: your score will be higher if your debts are
varied - that is to say, spreading your credit over purchases on cards,
loans, mortgages, etc.
What is my Score?
Credit scoring is calculated using mathematical formulas. The formula
is not something you need to know, but what is taken into consideration
to plug into the formula is something you should be aware of. This is especially
important if your score is low and you want to build it up, or if your score
is high and you want to maintain it.
One of the most common tools used in determining your number is the FICO credit scoring method founded in 1956 by Fair Isaac (now the Fair Isaac Corporation). Its calculation is based on the following:
• 35% payment history
• 30% amounts owed
• 15% length of credit
• 10% new credit
• 10% type of credit.
How to Improve your Credit Score
Taking into consideration the above factors in credit scoring,
here are some tips on how to improve your credit rating:
• Payment history: Pay your bills on time, and if that is a problem, request
from the lender a suitable arrangement. Get current on any debt that is
past due.
• Amounts owed: Keep your owing balances low - 35% or lower is recommended,
and do not open more accounts as a way to better your credit rating.• Length
of credit: Start building up a credit record as early as possible. If you
have a good credit rating, keep old accounts open.
• New credit: When shopping for new credit, request a short period allowance
for payment, such as 14 days or less; an extended period of time can get
you into trouble. If you open a new account, manage it responsibly.
• Type of credit: When you have a variety of loans, you are recognized as
a “seasoned” borrower, but when you only have a credit card debt, you are
considered “inexperienced”.
Note that an installment debt is a better type of debt than a revolving debt as it requires that you pay a fixed monthly installment until the loan amount is decreased to nil. A revolving debt refers to the different amount of money you owe every month on an open-ended credit card, in accordance with the number of purchases you made that month.
Keep in mind that a credit score cannot be changed overnight. Short of winning the lottery, you need to realize that it takes both time and discipline to improve your score.
About the Author: Mary Talbot is the content manager for Debt Consolidation Guides. She offers debt management solutions to help you get out of debt and stay that way.