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What is a Credit Score?
Your credit score is credit rating that represents an estimate of an individual's financial credit worthiness as calculated by a statistical model. A credit score attempts to measure the likelihood that a prospective borrower will fail to repay a loan or other credit obligation satisfactorily over a specified period of time. A credit score is typically based on the information in an individual's credit history report.
Creditors such as banks and credit card companies use credit scores to manage the risk posed by lending money to consumers. Examples of such uses include determining who qualifies for a loan, assigning an interest rate, assigning credit limits, and managing accounts that are already open (for example, treatment of accounts that are in default). The use of credit history report or identity scoring prior to authorizing access or granting credit is an implementation of a trusted system.
The most widely-known score in the United States is FICO score. FICO stands for Fair Isaac Corporation-the company that developed the mathematical formula to determine credit scores. It's a number that reflects your financial responsibility and helps lenders decide if you're a good credit risk or not. Your score is based on your credit history report; however, it does not come with the free report. You have to pay for the credit score; however, when requested by creditors, it's included with the report generated at the time of request.
How Is the Process?
The process consisted of five main factors that determine your Credit Score are:
- Punctual Payment History (35% of your score)
The factor that has the biggest impact on your score is whether you've paid past credit accounts on time. However, an overall good credit picture can outweigh a few late payments, which will continue to have less impact over time unless the late payment is a mortgage payment.
- Amounts Owed (30% of your score)
Having credit accounts and owing money doesn't mean you're a high-risk borrower. But owing a lot of money on numerous accounts can suggest that you are financially overextended and may be more likely to make some payments late or not at all. Part of the science of scoring is determining how much debt is too much for a given credit profile.
- Length of Credit History (15% of your score)
In general, a longer credit history will increase your FICO score because it shows that you can responsibly manage your available credit over time. However, even people who have not been using credit very long may get high scores, depending on how the rest of their credit report looks.
- New Credit (10% of your score)
People today tend to have more credit and to shop for credit more frequently. But opening several credit accounts in a short period of time can represent greater risk - especially for people with short credit histories. Requests for new credit can also represent greater risk. However, FICO scores are able to distinguish between a search for many new credit accounts and rate shopping. FICO scores generally do not equate your rate search with higher credit risk.
- Types of Credit in Use (10% of your score)
Your FICO score will reflect a combination of credit cards, retail accounts, installment loans, finance company accounts and mortgage loans. While a healthy mix will improve your score, it is not necessary to have one of each, and it is not a good idea to open credit accounts you don't intend to use. The credit mix usually won't be a key factor in determining your score, but it will be more important if your credit report doesn't have much other information on which to base a score.
When you apply for credit - whether for a credit card, a car loan, or a mortgage - lenders want to know what risk they'd take by loaning money to you. FICO scores are the credit scores most lenders use to determine your credit risk. You have three FICO scores, one for each of the three credit bureaus - Experian, TransUnion, and Equifax. Each score is based on information the credit bureau keeps on file about you. As this information changes, your credit scores tend to change as well.
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