Your credit scores affect many important aspects of your life. From the moment you open your first charge account, you enter into the world of credit.
Why a Credit Score Is a “Snapshot”
When a lender or insurance company makes an inquiry into your risk profile, they get a “snapshot” of your financial situation. Each time you open a charge account your score changes. Each time you miss a payment on a credit account, you score changes.
When you pay off a debt, your score changes again. Over time, the exact number goes up and down many times. What’s important to understand is where your credit score is at any given time and what can be done to increase it.
FICO – The 800-Pound Gorilla
The main source of information for many credit scoring companies is a company known as “FICO”. FICO stands for Fair Isaac Corporation.
This company started using formulas for calculating credit risk back in the late 1950s and became the model after which the other three companies took their lead.
FICO uses a proprietary formula to calculate the likelihood of repayment for every person with a credit history. Even though the exact formula isn’t known, we do know what the credit score factors are.
Credit Score Factors: FICO’s Formula
The information included in a credit report is provided by creditors to each of the three bureaus, who pay for the information. The data is incorporated into an individual’s credit history and that information is then used to determine the credit score.
Each area of credit information is given different weights when calculating the credit score. The following list details, in general, what percentages of a credit score are calculated for the information submitted:
- 35% Payment history
- 30% Outstanding debt
- 15% Length of credit history
- 10% New credit information
- 10% Credit mix
Payment History – 35%
As the largest portion of the formula, the payment history on an individual is extremely important. Late payments, missed payments, underpayments and other issues related to making payments on accounts are all incorporated into this section of the credit score.
Some creditors report late payments as soon as 10 days after the payment was due. Others wait until two payments have been missed. For this reason, it’s important for you to understand how each of your creditors reports data so you can better manage their accounts with each company.
Outstanding Debt – 30%
As debt accumulates, the balances are closely monitored by the credit bureaus. You have a limit to how much you can borrow. That credit limit is determined by your credit profile. If you take out a credit card and run up a $5,000 balance, then pay that balance off, you have proven your ability to service the debt.
However, if you take out a credit card and run up a $5,000 balance and only make the minimum payment each month, you’ve demonstrated to the credit bureau you can only pay a small portion of the total credit card debt and you receive a lower credit score as a result.
The total amount of outstanding debt (the money you owe) is calculated against the total amount of credit available (unused credit that can be used) and that information is combined with the other data to calculate the credit score.
If you make minimum payments on accounts and add additional credit cards in your name, the unused portion of those credit limits will help boost your credit score until you start using up the available credit, at which time the balances will begin hurting your credit score.
Length of Credit History – 15%
How long you keep an account is a factor in calculating credit scores. The longer you stay with a creditor, the higher your score will be. What becomes important is paying off balances and NOT closing accounts.
It is important to pay down the accounts and keep them open. This results in an improved credit score because you have a long relationship with your creditors and you have available credit to draw on.
The best thing to do when paying off a credit card or credit account is NOT to close the account. Keep it open and it will help your credit score stay as high as possible.
Also, using the same financing resource over and over again for different loans also helps this part of the credit score. In other words, financing three different cars with the same bank or credit union over the years will help your score.
New Credit Information – 10%
Opening new accounts and the activity on those new accounts is a factor in the scoring formula. New credit, as opposed to older accounts, indicates you have the ability to open up new lines of credit. This is important; it means your financial situation is positive because creditors are willing to loan you money or finance your purchases.
It also means you are active financially and not sitting still without acquiring and financing anything. Credit scores favor people who buy things and pay for them over time. It is ironic to consider that if you made every purchase with cash and never financed anything, your credit score would be very low, despite the fact you can afford everything you purchase.
Type of Credit – 10%
When you finance your home purchase with a mortgage, that is a loan. When you open up a credit card, that is a loan. When you receive an account which you can charge gas or groceries to, those are also loans. They are all loans, but they are different kinds of loans. Mortgages are a form of financing that is different from a credit card. This difference is important to the credit bureaus.
Having different types of credit accounts lets them know you are able to handle different kinds of financing. Installment agreements (like car loans), revolving lines of credit (like department store credit cards), and other types of financing help you achieve a higher credit score by demonstrating your ability to handle the different types of credit lines.
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How Your Credit Score is Calculated
For most people, the number for their credit score is between 500 and 800. The lower the number, the less attractive you are to potential lenders.
The credit bureaus take all the information they accumulate, run it through their unique formulas, and the end result is the number. This number changes frequently with the passage of time and many items, both positive and negative, will cease to be included over time.
Positive items can remain on your credit report indefinitely, however, most closed accounts are aged off after 10 years. Most negative items remain on credit reports for 7 years. It is important to review your credit reports regularly and take steps to eliminate negative information and enhance the positive data.
The Big Three
There are three main consumer credit reporting agencies in the United States – Equifax, Experian, and TransUnion. These three provide their data to their customers for a fee.
Their data is about what you owe, who you owe it to, and how long you’ve owed it. Each company computes and calculates credit scores using their own “secret” formula, but the fact is they all base their formulas on the same criteria as the big boy on the block – FICO.
Credit Score Fluctuation
Because of constant fluctuation of about 20 points around an average score, you should be aware of where your credit score sits and what can be done to increase the number as high a level as possible.
Good credit means consumers pay lower interest rates on loans, get cheaper insurance coverage and have improved job opportunities.
A good credit score saves money, provides better rates and can even help get a really good job. Bad credit means the opposite to the above will occur and more. Bad credit affects lifestyle and opportunity.
How to Improve Your Credit Score
You can improve your credit score by paying your bills on time, not over-borrowing, and maintaining low credit balances. It can take time, but there are solutions to increase your credit scores.
You can choose to learn the credit reporting laws and dispute negative items on your own or you can have a credit repair company do it for you.
Credit repair involves a process of challenging, validating, and verifying the accuracy of information contained on your credit reports. Only the data which helps your score stay high is retained and the bad information which lowers it is eliminated.
Credit Score FAQs
What is a FICO score?
The FICO score is a branded credit score developed by Fair Isaac Corporation. Most lenders use the FICO score. A FICO score can only be purchased through myFICO.com. Some credit card issuers also offer them for free.
If you purchase your score from anywhere else it is not your FICO score. Each of the credit reporting agencies has its own version of a credit score. Equifax calls its score BEACON, Experian – PLUS, and TransUnion – EMPIRICA.
Why are the credit scores from each credit bureau different?
Each of the three credit reporting agencies – Equifax, Experian, and TransUnion – uses a slightly different formula calculation to come up with a credit score.
In addition, each bureau has different information included in the credit report. Not all creditors report to all three bureaus, so one or two of the credit reports might contain account history the others don’t.
How is the credit score calculated?
Credit scores are calculated using five pieces of information:
- Payment history
- Debt level
- Age of credit
- Mix of credit
- Credit inquiries
Will multiple loan applications hurt your credit?
The short answer is – it depends. If you shop for a loan within a 14-day period, you will probably be safe. Depending on the type of lender, the time frame could increase to as much as 45 days. Most credit scoring models have been designed to recognize when you’re rate shopping and avoid penalizing you.
For example, the most recent FICO scoring formula ignores all mortgage or auto loan inquiries made within a 45-day window. Older versions of the FICO score used a 30-day or 14-day window.
Once the “window” has passed, loan inquiries are bundled together and treated as one inquiry. Whether (and when) your score will be influenced by rate shopping depends on the credit scorer.
Does closing a credit card help or hurt a credit score?
It’s more likely that closing a credit card will hurt your score more than it will help. If the credit card has a balance, it will definitely drop after you close the card. That’s because 30% of your score is based on credit utilization – the amount of available credit being used.
When you close a credit card, there is no available credit, so the credit utilization calculation goes up to 100% immediately. As a result, your score drops. Even if the credit card has a zero balance, the total credit utilization – which considers all credit card balances and available credit – is better because there is unused credit available.
If other credit cards have balances of over 30% of the credit limit, closing a single credit card could hurt your score. Also, if you have no other credit cards, or your only other cards are store credit cards (and they are closing a major credit card), your score could drop.
The mix (or type) of credit is 10% of your overall score and looks at your experience with different types of credit products, including both credit cards and loans. Please note, closing the oldest credit card could impact your score in terms of credit age (15% of your score) as well as credit utilization.
How often does a credit score change?
Your credit score is like a snapshot picture. You can check your score one day and notice that it’s moved up or down from the previous day.
Your score can change daily depending on how often your credit report is being updated. Creditors, lenders, courts, and others are continuously making updates to credit reports throughout the month and will change to reflect those updates.
Will a prepaid credit card improve your credit score?
No. Prepaid cards are not credit cards (they’re more like VISA-branded debit cards), and they’re not listed on your credit report.
A secured credit card, on the other hand, requires a deposit similar to a prepaid credit card, but purchases don’t take away from your deposit. Instead, you’re required to make payments on your balance because it’s an actual credit card. Certain secured credit cards are listed on your credit report and can improve your credit score if used correctly.
Credit Repair Options
You can attempt to repair your credit on your own, however, the process is rather complicated. It involves challenging information contained in each of the three credit bureau’s databanks, verification of debt from creditors and other time-sensitive procedures.
If not done properly, it can actually result in a lower score rather than the hoped-for higher score.
Most consumers turn to a credit repair company which can perform the intricate tasks associated with repairing credit with greater control and higher success rates.
The Best Credit Repair Option
Among the hundreds of companies offering credit repair services, there’s one company which stands out from the others. They have 28 years of experience dealing not only with the credit bureaus but also with the multitude of creditors submitting information to the bureaus.
They also have hundreds of thousands of satisfied clients. Check out our review of Lexington Law to find out more about them.
Lexington Law Helped This Client Remove Charge-Offs from His Credit Report:
This client’s credit scores have dramatically improved since there are no longer any negative accounts on his credit report. Here is a snapshot of his scores since signing up with Lexington Law:
Lexington Law Client Testimonials:
I have recommended your services to all of our friends and family and will continue to do so in the future. Now my wife is in the process of working with you to get her credit cleared up. I couldn’t be any happier. Thank you.”
— M.F., Lexington client
— T.B., Lexington client
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