Credit ScoreA credit score is a numerical representation of how likely you are to pay your debts in a timely manner. It is calculated by a certain mathematical formula based on the statistical analysis of your credit report. This three digit credit score determines your creditworthiness, i.e. your ability to repay your loan. It is therefore an important statistic determining your financial future. Credit scores are used by lenders like banks and credit card companies to anticipate the risk involved in lending to a certain customer. These lenders use the credit score to determine the rate at which they should lend you money.
In the United States, there are three main credit bureaus that assign credit scores based on your credit report – Equifax, TransUnion and Experian. All of these credit bureaus issue credit scores to you according to individual evaluation methods. Since these bureaus work independently you may end up scoring differently on each bureau's radar. This lack of consistency is one of the main drawbacks of the credit scores. A credit score, nonetheless, is an important tool that the lender can use before he gives you any credit.
Since credit scores are issued by independent agencies, they use the credit reports in their database to calculate the scores. The credit reports in turn may be based on credit history that each agency might have about you, and these may differ. To counter this disparity, lenders use all the three scores to determine your creditworthiness.
How is a credit score calculated?The most common method used for calculating credit scores is the FICO credit score, developed by Fair Isaac’s Corporation. Having been pioneered by the corporation, the method is named after it. The corporation sells this information at a price. Each of the three major bureaus uses the FICO score and also sells its own version of credit scores – Equifax’s “Beacon”, Experian’s “Experian/Fair Isaac Risk model” or TransUnion’s “Emperica.”
The FICO credit scoreThe FICO score is the most widely used method to calculate a credit score. In this method varying weightage is given to the different factors that make up your credit report. The FICO credit score is a three digit number ranging from 501 to 850. The higher the score the better. Basically there are five parts to a credit score:
- History of payments: Approximately 35 percent of a FICO score involves your history of credit payments. Things like late payment or bankruptcies would negatively affect your credit score.
- Your accounts outstanding: The amount that you owe on all your accounts, the available credit that you are currently using and your accounts with balances would comprise about 30 percent of your score.
- The span of your credit history: The longer it is the better your chances of scoring high. It makes up about 15 percent of the credit score. However, you may get a reasonably high score even if your credit history is short, provided it reflects good credit management.
- Credit that you recently applied for: This would make up about 10 percent of your score. In case of a number of fresh credit applications your score may be affected negatively. So you should be careful and focus the credit rate shopping in a short period of time, say 30 days, to avoid getting lower scores.
- Other factors: This would make up the rest of the 10 percent of the score. Having a mix of credit alternatives will help your credit score.