07 Aug What Does Your Credit Score Really Mean?

A credit score is simply a number based on the analysis of a person’s credit history. It’s utilized by lenders to determine a person’s credit-worthiness. In other words, a credit score is used to determine your ability to pay a loan or potential credit card bill on time. Lenders typically use FICA to evaluate a borrower’s risk, as it’s the most well-known scoring model. Thoroughly understanding how to interpret your credit score will allow you to make informed financial decisions. Here is a comprehensive view of what a credit score is and how it affects your finances.

What is a Credit Score?

A credit score is a three-digit number that tells lenders the risk they are taking if they allow an individual to borrow money. Based on a set of variables including the number of accounts, amount of money owed, and payment history, credit scores also determine interest rates and credit limits. This is referred to as identity scoring and is relied on to enforce security policy. High-risk credit scores present a low risk to lenders,

Credit scoring is primarily used by banks, insurance companies, mobile phone services, and by apartment managers. There are several data points used to calculate a credit score. These are the five categories that are known to affect credit scores.

Payment History

Payment history affects 35% of the FICO score. This takes into account mortgages, credit card history, previous loans, and other credit accounts in the borrower’s name. Late payments have a big influence over a credit score, but factors such as how often they occurred, the degree of lateness, and whether being late was a recurring issue is also considered. Foreclosures and bankruptcies will have a significantly negative impact on your credit score.

Amount of Debt Owed

This refers to the available credit currently being used and less about the dollar amount owed. Having more available credit is viewed in a more positive light than how much money is owed. For example, owing $2,000 on a credit card with 40% available credit is considered better than owing $300 with only 20% available on your credit line. The process looks at accounts and their balances, as well as the debt owed on installment loans compared to the initial balance.

Credit History Longevity

Lengthier credit histories that reflect responsible credit practices are considered a positive variable in determining credit scores. Longevity implies the reliable use of credit. This process involves studying the age of the borrower’s accounts and represents 15 percent of the FICA score calculation.

Diversity of Credit

Lenders want to know that borrowers have a history that reflects a variety of credit lines such as auto loans, mortgages, credit cards, and other types of debt related accounts. This accounts for 10% of the FICO score, however, it has more relevance when the other categories contain little information.

New Credit

Individuals who open many new accounts in a short period of time are seen as a high credit risk. Applications for credit cards and loans in a 12 month period are also factored in. This category accounts for 10 percent of your credit score.

Excellent Scores

Individuals with a credit score that ranges from 720 to 850 are in the excellent range and are considered reliable when it comes to paying bills on time so they will usually receive lower interest rates for credit cards, loans, and mortgages. This score means that the borrower had a very low balance on credit card accounts and essentially no late payments.

Very Good Scores

If you have a credit score between 740 and 799 then you’re considered to be in the very good range. This means you pay the majority of your credit card and loan debt on time. In addition, your credit card balance will be lower than your account limit.

Good Scores

A credit score between 670 and 739 is considered to be in the above average range for consumers in the United States. Individuals that fall in this range may still obtain decent interest rates, but it will be harder to qualify for certain types of credit.

Fair Scores

Credit scores ranging from 580 to 699 are placed in this category. These are individuals with many nicks on their credit history but no bankruptcies, foreclosures or serious delinquencies. Typically, individuals with a fair credit rating may still be able to receive credit from lenders, but the interest rates will be higher.

Very Poor Scores

People with scores between 300 and 579 have a lot of problems with their credit history. This usually involves more than one default, a bankruptcy or foreclosure. It is very hard for individuals with very poor credit scores to qualify for new credit. Individuals in this category should seek out financial counseling to repair their credit.

Statistics show that in the United States one in nine individuals hold the distinction of having a credit score above 800. If you’re making a major purchase such as buying a home or car, your credit score can save you a substantial amount of money. Understanding your credit score and knowing where you stand can provide the essential information needed to make informed financial decisions.