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A credit score
is a number that is calculated based on your credit history to
give lenders a simpler "lend/don't lend" answer for people who
are applying for credit or loans. This number helps the lender
identify the level of risk they may be taking if they lend to
someone. While the same end result can come through reviewing
the actual credit report
(which lenders usually do), the credit score is quicker and less
subjective. The system awards points based on information
in the credit report, and the resulting score is compared to
that of other consumers with similar profiles. With this
information, lenders can predict how likely someone is to repay
a loan and make payments on time.
Although
there are several scoring methods, the score most commonly used
by lenders is known as a FICO because of its origins with
Fair Isaac and Company.
Fair Isaac is an independent company that came up with the
scoring method and software used by
banks and lenders, insurers and other businesses. Each of the
three major credit bureaus (Experian,
Equifax and
TransUnion) worked with Fair Isaac in the early 1980's to
come up with the scoring method.
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Accessing Your Score
In the
past, your credit score was not accessible to you…but laws
have changed and it is easy to get your own credit report
using the internet. Many times this service is free. |
The credit
score itself can range from 300 to 900. The formula for
exactly how the score is calculated is proprietary information
and owned by Fair Isaac. Here, however, is an approximate
breakdown of how it is determined:
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35% of the
score is based on your payment history. This makes sense since one of the primary reasons a
lender wants to see the score is to find out if (and how
timely) you pay your bills. The score is affected by how many
bills have been paid late, how many were sent out for
collection, any
bankruptcies, etc. When these things happened also comes
into play. The more recent, the worse it will be for your
overall score.
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30% of the
score is based on outstanding debt. How much do you owe on car or home loans? How many
credit cards do you have that are at their credit limits? The more
cards you have at their limits, the lower your score will be.
The rule of thumb is to keep your card balances at 25% or less
of their limits.
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15% of the
score is based on the length of time you've had credit. The longer you've had established credit, the
better it is for your overall credit score. Why? Because more
information about your past payment history gives a more
accurate prediction of your future actions.
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10% of the
score is based on the number of inquiries on your report.
If you've applied for a lot of credit cards or loans, you will
have a lot of inquiries on your credit report. These are bad
for your score because they indicate that you may be in some
kind of financial trouble or may be taking on a lot of debt
(even if you haven't used the cards or gotten the loans). The
more recent these inquiries are, the worse for your credit
score. FICO scores only count inquiries from the past year.
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10% of the
score is based on the types of credit you currently have.
The number of loans and available credit from credit cards you
have makes a difference. There is no magic number or
combination of types of accounts that you shouldn't have.
These actually come more into play if there isn't as much
other information on your credit report on which to base the
score.
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