The Credit Score: What Does It Mean?
The credit score predicts the statistal chance of a consumer becoming 90 days late or more on a particular loan obligation over the next 24 months. Here are the scoring odds:
A credit score above 800 = 1485 to 1 odds
720 to 799 = 649 to 1
680 to 719 = 112 to 1
620 to 679 = 47 to 1
Below 620 = 15 to 1
Lenders use your credit report and score to objectively judge your reliability as a loan candidate. Your credit report indicates your ability to handle debt responsibly and is used to help banks decide if you are a desirable loan customer. A high credit score can help you lock in low APR rates or secure special deals on loans, while a low credit score may prevent you from securing loans and hinder your ability to buy a car, open a credit card or rent a home. A history of inability to manage your credit successfully will make lenders uncomfortable about trusting you with additional funds in the future.
What Makes Up a Credit Score?
Your credit score is determined by an algorithm developed by the Fair Issue Corporation (hence its other name of FICO score). Three corporations, called “credit bureaus”, specialize in collecting and reporting on financial histories. Those three companies are Equifax, Experian and TransUnion. While, the exact formula used to calculate your credit score is a tightly guarded industry secret, these companies provide general guidelines about financial behavior that can affect your credit score.
1. Payment History
Thirty-five percent of your credit score is made up by your payment history. This includes late payments, collections, and even bankruptcies and tax liens. Each type of account will stay on your credit report a specified period of time and each type of derogatory will hurt your score differently.
2. Debt Ratio
Your debt ratio is the amount of revolving credit (i.e. credit cards) you owe in relation to the amount of credit you have available. For instance, if your credit limit is $10,000 and your current balance is $2,000, your debt ratio would be 20%. While, ideally, you would have your debt ratio at 0%, we usually recommend you are at least at 30% or lower.
3. Length of Your Credit Files
Your length of credit is how long you have had credit. At face value, this seems like something you couldn't really do anything to fix. However, there are ways you can hurt yourself here. If you close out your older cards, even if they have higher interest rates, it will hurt your score. The credit scoring model has no memory or credit cards you close: if you close out that fifteen year old card you will get no credit for it!
4. Credit Mix
Types of credit include revolving, installment and mortgage loans. By having different kinds of credit open, you show creditors that you are responsible and able to handle different kinds of responsibilities.
5. Inquiries
Inquiries are marked on your credit report when you ask for new credit (i.e. when you apply for a home loan). Inquiries made by yourself or for unsolicited offers do not count against your score, but are shown on your report. It is important to note than when searching for a home you are allowed unlimited inquiries over a one month period since it is assumed you are rate shopping.
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