A credit score is a numeric summary of the items that are in your credit report. How exactly does a credit score work?
FICO (Fair Isaac Corporation)
FICO is a publicly traded company. Their website states that they “use predictive analytics to help businesses automate, improve and connect decisions across organizational silos and customer lifecycles.” One of the analytics developed by firm is the most widely known type of credit score.
FICO credit scores range between 300 and 850. The higher the score you have, the better. In general, scores above 700 suggest a relatively low credit risk. Scores below 600 indicate a high risk. Those scores may result in credit denial or higher interest rates being charged.
FICO is not the only credit scoring system credit companies use. TransUnion and Equifax use FICO. Experian, the third of the three major credit reporting agencies, uses a system called PLUS. Credit scoring systems called VantageScore, TransRisk and ScoreX are also used by credit agencies.
(Tip: Keep in mind, when you order a free credit report, there will be no score on it)
Whichever credit scoring form is used, your credit score is a statistical analysis of your credit worthiness. This translates to the likelihood that you will pay their bills. Studies indicate that credit scores are good predictors of how you will re-pay your debt.
Elements of a Credit Report
The main elements of a credit report and score calculated by FICO are as follows:
The percentages refer to the weight that each factor is given in compiling your credit score.
Your payment history suggests two things. It reports on if you pay and if so, whether or not you paid time or had late payments. This is the most important credit score element. It speaks to your ability to pay back your creditors.
The more late payments you make, the more negatively it will reflect on your credit score. In fact, many underwriters, when trying to determine whether or not to extend credit, will query you about what you caused you to be late on a payment. Payment history includes all credit cards, mortgage, car notes and any other type of formal credit you’re paying on. These actions are reported to the credit bureaus each month.
Your debt ratio is actually called a debt to income ratio (DTI). It is the percent of your gross income that goes toward the debt you are responsible for. For example; if you make $5,000 per month and you have $1,000 you pay toward your debt, you DTI would be 20% ($1,000 divided by $5,000).
This important figure determines whether you’re carrying too much debt for your income. The lower this score, the better. If you go over 30% or 34%, it may negatively impact your credit score.
Length of Credit History
This lets creditors know how long you have maintained a credit history. They want to know that you’re responsible enough to handle credit. If you’re new to obtaining credit, it might suggest you’re a higher risk to re-pay the debt.
Type of Credit
This reports information on the type of credit you have. Is it mainly mortgage and car payments which are secured debt or is it unsecured debt like credit cards? Too much unsecured debt might raise questions in the minds of the underwriters.
Number of Credit Inquiries
If you’ve tried to get credit too many times over the period of a year, this could have a negative impact on your credit report. It’s noted on the report when anyone pulls a credit report on you. It could raise questions with your creditors about why you are seeking credit from many sources. It could mean you’re becoming financially over-extended.
Other Credit Report Elements
In addition to the above elements, the following information also appears in your credit report:
Public Record- Information on any liens opened on you for unpaid taxes, bankruptcies, legal judgments or lawsuits filed against you and child support requirements are also included in your credit report.
Personal Information- Your name, SSN, birth date and addresses are listed. Your places of employment will also be there along with information on your military service (if any).
Disputing Your Credit Report
If you find an incorrect piece of information, you can dispute it in writing to the credit bureau that provided the report. The credit bureau has 30 days to investigate and report the results back to you.
Tip: If there’s an error with one bureau, it’s also probably in the other two. So, make sure you check the reports from all three major credit reporting agencies, also.