Tuesday, June 3, 2014

How is Your Credit Score Calculated?

A credit score mirrors your financial history. This simply means how you have handled payments, debts and liabilities over a period of several years. It is important to know your credit score before applying for a loan, mortgage or a new credit card.

A credit score is basically a number based on a statistical analysis of the credit report file issued by any of the three major credit bureaus in the US – Experian, TransUnion and Equifax.

There can be a number of methods to calculate credit scores. The most widely known type of credit score is, however, FICO score, which has been developed by FICO (formerly known as Fair Isaac Corporation). Banks, mortgage lenders and credit card providers, all use FICO score to ascertain the financial capability of a borrower.

While a credit report is available for free (one free credit report every year from each of the three credit bureaus), the accessibility to your credit score is not without a fee, which is charged according to the FTC regulation. Generally, the FICO score ranges between 300 and 850, and a score over 600 is considered good, and can make you eligible to apply for loans at most lenders.

Income is not considered when calculating a credit score, but there can be several factors that can affect it. While it is not possible to exactly determine the way how it gets calculated by the credit bureau, we know about some components that make up a credit score.

  • Payment History (35%): Make payments on time and avoid things like late payments and bankruptcies to maintain a clean payment history.
  • Debt Burden (30%): High credit limit and low amount of debt can be the key to a good credit score. Pay special attention to credit card debt to limit ratio.
  • Account History (15%): The older your credit account, the better is your score.
  • Types of Credit Used (10%): Having a mix of different types of credit accounts, such as credit cards, mortgages and personal loans, can be quite helpful.
  • Credit Inquiries (10%): Don’t apply for loans at too many lenders simultaneously. More lenders mean more credit inquiries, which can adversely affect your credit score.