17 Mar Credit Score – Understanding Credit Scoring

Understanding Credit Scoring

Most people know they have a credit score and that it impacts many aspects of their life including access to financial products, borrowing costs, insurance rates, job applications and housing access. We at Credit Fair-E think it is important to understand a score that factors into so many facets of our lives. Credit scoring uses statistical models to evaluate your credit risk by comparing credit information about you to the credit performance of others with similar credit scores. These models have been developed and based on millions of credit report files and are considered to be excellent predictors of the likelihood that an individual will repay a loan. The output of these models is your credit score. The credit score is used, along with your credit report and other information from your credit application, to determine whether your application will be approved. Credit scores are used to speed up the loan approval process and allow lenders an objective way to assess the applicant’s ability to repay the loan. Credit scores do not include race, religion, national origin, gender, or marital status as factors. Your credit score at any given time is only a snapshot based on the information available at that time. Credit scores change over time as the information about you changes. Your scores are based on 5 core factors, listed in order of importance:

 

  • Payment history – Accounts for 35% of your credit score. Paying your bills on time will help keep your scores high, while late payments, charge-offs, and collections will hurt.
  • Outstanding debt – Account for 30% of your credit score. The amount of money you currently owe your creditors. While this category looks at the total amount that you owe (credit cards, home loans, car loans, etc.), it’s the credit cards –or revolving accounts – that have the most impact on your credit score. In order to maximize your scores in this section, you should keep your balances in relation to your credit limits as low as possible.
  • Credit history – Accounts for 15% of your credit score. This category specifically measures how long you’ve had credit. It does so by reviewing all of your accounts and looking at the opened dates. The longer you’ve had credit the more points you’ll earn in this section. This is just one of the reasons why it’s not a good idea to close old, good accounts.
  • Pursuit of new credit – Accounts for 10% of your credit score. Basically, when you apply for credit an inquiry will post to your credit report showing that you’re seeking credit. Having too many inquiries in a short period of time can hurt you. As a general rule of thumb, try to avoid excessively shopping for credit – only open a new credit account when you really need it. (Tidbit: By law inquiries remain in your credit reports for two years. However, only inquiries in the last 12 months are considered in your credit score calculation.)
  • Types of credit in use – Accounts for 10% of your credit score. This section is looking for a healthy mix of accounts. Diversity is key – having a mix of different types of accounts including credit cards, auto loans, mortgage loans, etc., will insure you do well here.

It’s important to note that your income level is not a factor in calculating your credit score. It all depends on the past use of credit and the factors described above.