HOW IS A CREDIT SCORE DETERMINED
Your credit score is a cumulative measure of success and failures assigned to a person based on their past credit worthiness. The most common score used by lenders is calculated by the Fair Isaac Corporation, also known as FICO. Your FICO score can range anywhere from 300-850. On the FICO scale the higher the number the better.
On that same scale a score of 300-599 is very bad.
600-649 is poor.
650-699 is fair.
700-749 is good.
750-799 is very good.
800-850 is excellent.
Another scoring model used by lenders is the Vantage Score. In the past Vantage Score had a different numerical value ranking poor to excellent credit. However, Vantagescore 3.0 was implemented in 2013 to help lenders better implement the Vantagescore model and to help lower confusion for consumers checking both scores. Now Vantagescore uses the same range as FICO in determining poor to excellent credit. They do differ slightly in how they collect your score and how you are penalized for late payments and collections. FICO is slightly more forgiving in late payments. Vantage Score will penalize you more harshly for late mortgage payments as opposed to other types of credit. FICO also tends to not penalize you for collections less than 100 dollars whereas Vantage Score penalizes you for any and all collections. FICO and Vantagescore aren’t the only scoring models on the market. Lenders use many different scoring methods to determine your creditworthiness. Despite the multitude of options, FICO and Vantagescore are likely the only scores you’ll ever personally see.
Understanding Credit Score Criteria
There are several different criteria for how these scores are determined based on your credit history. Your payment history, the amount of debt used, the length of your credit history, your new credit and inquiries and finally your different types of credit. Each of these criteria are awarded certain percentages when determining your score.
Although having overall credit worthiness is important the biggest percentage is awarded to your payment history. Credit bureaus factor 35% of your score on whether or not you pay your bills on time. Having on time and regular payments are incredibly important in maintaining excellent credit.
Almost equally important is not using all the credit awarded to you. They factor 30% of the amount of credit you owe. This is also called your “utilization ratio.” Lenders like to see a consumer have 70% of their available credit open. The lenders theory is that people that have used most of their credit tend to miss payments. So if you have a credit card with a 500 dollar limit you should only be utilizing 150 dollars or less at any given time.
The length of time your accounts have been open or the last time they were used is also a factor. The average age of your accounts accounts for 15% of your credit score. Having a closed account isn’t necessarily a bad thing if it is older and was in good standing.
New credit and inquiries as well as the different types of credit you have account for 10% each of your overall score. This is why opening several new lines of credit or applying for credit several times in a short amount of time is a bad thing. Also showing that you can manage several types of credit like installments loans and revolving credit give lenders faith that you will fulfill your obligations to them and be a great candidate for borrowing.
Knowing how a score is determined can help you put into practice the best credit habits to help you improve your bad score or help maintain a good score you may already have. Another great way to practice good credit habits is to monitor your reports and know what is changing with your score.
Credit Monitoring & Why Scores Differ
Now that you understand credit and how it’s determined its time to start putting these good habits into play and utilize your credit opportunities and make them work best for you. It’s important to monitor what is already reporting on your credit as well as keep up with any updates that may happen during your credit usage. Studies show that close to 80% of consumers have erroneous items reporting to one if not all of the three major credit bureaus Transunion, Experian and Equifax. These errors can stem from inaccurate information supplied by creditors, errors reported by collection agencies or identity theft. Someone else or someone else’s error may be costing you thousands of dollars without your knowledge. You can take action against this. The Fair Credit Reporting Act or FCRA guarantees you have access to one free credit report annually. This is easy to obtain at annualcreditreport.com. This is a copy of your three credit reports from the three major reporting bureaus. This free report is mailed to you and usually comes within a few business days of you requesting it or can be emailed to you on the same day. Keep in mind this will only give you your three reports and not your overall credit score. This is only guaranteed for free once a year.
There are numerous free credit monitoring sites such as Credit Karma that give you a good base line of what is reporting to your bureaus. They don’t always give you a full picture of what is happening though. Most of these free monitoring sites only show you one or two of the reporting bureaus. Rarely do they report all three and give you a legitimate FICO score.
Sites such as Identity IQ that do report from Transunion, Experian and Equifax can be found for only a dollar trial. The trial can easily be cancelled after you’ve printed and viewed your report or you can opt to stay with them for a reasonable monthly subscription. The benefits of maintaining a credit monitoring service are astounding. Not only will you receive monthly updates on your credit score and progress but it also guarantees protection from identity theft and fraud prevention.
Now that you are monitoring your credit you may notice that your scores can differ widely from site to site. This is due to several different reasons. Like i mentioned above the free monitoring sites don’t always report all three of the bureaus. Different credit monitoring sites may also use different scoring models that aren’t FICO, though this model is the most common. However there is also a little talked about scoring model known as the Industry Option Score. This is a series of FICO scores that is different for each leading industry lender. You could apply for a credit card, car loan and mortgage on the same day and your scores would vary for each. They would be close but different sometimes as much as 15 points. This is just another reason to have and keep a baseline of what is reporting and how you are affected by each line of credit.
Now you have the tools to maintain good credit. It’s time to start rebuilding past credit mistakes. Let’s make sure your credit is accurate and as strong as possible.