Your credit score, or your FICO score, is determined using a formula created by the Fair Isaac Corporation. Three different bureaus keep track of the credit information that is used to determine your FICO score. These three credit bureaus, called Experian, Equifax and TransUnion, keep a record of your credit which is identified by your social security number. Credit scores range from 300 to 850, and according to Whatsmyscore.org, the majority of Americans score in the 600s and 700s. Your credit score can have an important impact on money that you borrow--the difference between a 600 score and an 800 score can mean the difference between many thousands of dollars in interest over the life of a loan.
Determining a FICO Score
Your FICO score takes several factors into account to arrive at the overall numeric score that represents your credit worthiness. Thirty-five percent of your FICO score is based on your payment history; 30 percent is based on how much you owe; 15 percent is based on the age of your credit cards. Ten percent is based on the amount of new credit you apply for. Ten percent is based upon the variety of different types of credit you use.
Payment History
Your payment history is an important factor of your credit score, making up 35 percent of the total score. Payment history means a number of different things. It means more than just a history of paying on time, although that is important. If you pay your credit cards 30 days late, 60 days late or 90 days late, that is reported to the credit bureaus. Even a single late payment can dramatically lower your score. However, your payment history also includes other information besides these late payments. If you declare bankruptcy, foreclose on a house, settle a debt for less than you owe, or have a short sale on a home all of these things show up in your payment history. These adverse actions remain on your credit report for up to 10 years, and lower your credit score dramatically.
Amount Borrowed
The total amount of money you owe is also an important consideration determining your credit score. There are two components which factor into how the debt you owe is analyzed. First, the credit score looks at your debt-to-income ratio--how much you owe versus how much you make. The more money you make, the more money you can afford to borrow. This factor also considers the distribution of how much money you have borrowed. This factor, called your debt-to-credit ratio, considers how much of your available credit you use. Credit scores go down if you "max out" your credit, or borrow up to the limits available to you on your credit cards. So, a person who has two cards with a $100 limit on each, who borrows $50 on each of the two cards, will have a better credit score than a person who has one credit card with a $100 limit who borrows $100 on that one card.
Age of Credit and Inquries
The average age of your credit cards is also a factor in your credit score. A long history of good use of credit suggests to lenders that you are a good credit risk, and raises your credit score. When you open a new account, your average age of credit goes down, so it is a good idea to avoid opening too many new accounts.
Inquiries are a related factor, which are also adversely affected by opening new lines of credit. Each time you apply for credit, the credit card company looks at your credit report. This is called an "inquiry" or a "pull" and it shows up on your credit report. Too many inquiries can lower your credit score because it may suggest to lenders that you are borrowing more than you can handle.
Types of Credit
Creditors like to see that you use a wide variety of credit. They prefer a mix of secured and unsecured debt. Unsecured debt refers to credit cards, or other debt that does not have collateral (like a car or a house that the bank can take back if you don't pay). Secured debt refers to things like mortgages and car loans. Having a mix of different types of credit available shows lenders that you are responsible with credit, and raises your credit score.
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