The purpose of my next 2 articles is to hopefully provide a brief, but useful, guide to how the infamous credit scoring system works.
As you may or may not know, the credit scoring model seeks to quantify the likelihood of a consumer to pay off debt without being more than 90 days late at any time in the future. Credit scores have many different ranges, however, the score that is used by 90% of lenders and creditors in this country is the FICO score, and the FICO score range is 300 to 850. Credit scores can range between a low score of 300 and a high score of 850. The higher the score, the better it is for the consumer, because a high credit score translates into a low interest rate when making large purchases (ie. a car or home).
Only one out of 1,300 people in the United States have a credit score above
800. On the other hand, one out of every eight people have a score falling between 500 and 600.
The Five Factors of Credit Scoring
Credit scores are comprised of five factors. Points are awarded for each component, and a high score is most favorable. The factors are listed below in order of importance.
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1. PAYMENT HISTORY – 35% IMPACT
Paying debt on time and in full has the greatest positive impact on your credit score. Late payments, judgments and charge-offs all have a negative impact. Delinquencies that have occurred in the last two years carry more weight than older items.
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2. OUTSTANDING CREDIT CARD BALANCES – 30% IMPACT
This factor marks the ratio between the outstanding balance and available credit. Ideally, the consumer should make an effort to keep balances as close to zero as possible, and definitely below 25% of the available credit limit at least 2-3 months prior to trying to purchase a home.
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3. CREDIT HISTORY – 15% IMPACT
This portion of the credit score indicates the length of time since a particular credit line was established. A seasoned borrower will always be stronger in this area.
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4. TYPE OF CREDIT – 10% IMPACT
A mix of auto loans, credit cards and mortgages is more positive than a concentration of debt from credit cards only. You should always have 1-2 open major credit card accounts.
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5. INQUIRIES – 10% IMPACT
This percentage of the credit score quantifies the number of inquiries made on a consumer’s credit within a twelve-month period. Each hard inquiry can cost from three to fifteen points on a credit score, depending on the amount of points someone has left in this factor. Note that if you pull your credit report yourself, it will have no effect on your score.
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Remember that the credit score is a computerized calculation. Personal factors are not taken into consideration when a credit report is generated. It is merely a snapshot of today’s credit profile for any given borrower, and it can fluctuate dramatically within the course of a week.
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Getting a Free Copy of Your Credit Report
If you want to make sure that your credit report is accurate, then the best place to go is AnnualCreditReport.com. AnnualCreditReport.com is a centralized service for consumers to request free annual credit reports. It was created by the three nationwide consumer credit reporting companies – Equifax, Experian and TransUnion.
AnnualCreditReport.com provides consumers with the secure means to request and obtain a free credit report once every 12 months from each of the three nationwide consumer credit reporting companies in accordance with the Fair and Accurate Credit Transactions Act (FACT Act).
Keep in mind however, that annualcreditreport.com does not offer free credit scores with your reports. However, you can purchase your score at the same time that you order your free report from each bureau. To have a complete picture of where you stand with your credit, it is always recommended that you order your scores at the same time.
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One Word of Caution (from my personal experience)
When I recently checked my credit report, and paid for my credit scores, I wasn’t aware that I also signed up for a montly subscription of $15 to a couple of the companies. About 2 weeks later, I was automatically billed $15 from two of the companies. In order to cancel the subscription I had to call. So, if you don’t want to be automatically billed, learn from my mistake, and be sure to cancel before they automatically bill you.
–Written on October 15, 2013.