What Is Credit Scoring?

Credit scoring is an important tool for lenders to use in evaluating potential customers. Many factors go into a credit score. It is important for consumers to understand credit scoring and its determining factors, as well as their own individual scores and what they can do to manage their credit record in a positive way.

Definition

Credit scoring is a way for creditors to decide your eligibility for credit. The credit scoring system is used by lenders to determine interest rate and payment terms for mortgages, credit cards and auto loans. Whenever a credit score is mentioned, it is usually what is commonly known as the FICO score, which was developed by the Fair Isaac Corporation.

Good Scores

FICO scores are the most commonly used credit scoring system today, with scores ranging from 300 to 850. Higher scores are better, and most consumers have credit scores in the range of 600 to 700.

FICO Score Components

Your FICO score is made up of different components. Each one of these is factored in at different percentages. The following three are specific to your credit accounts and payments.

1. Payment history -- 35 percent of FICO score

Looks at how timely your credit accounts have been paid. You can hurt your credit score by having late payments or bankruptcies. Prompt payments, on the other hand, can improve your score.

2. Total debt -- 30 percent of FICO score

The number of open accounts with balances is considered, as well as how much of your available credit is being used. The less available credit you have, the lower your score will drop.

3. Length of credit history -- 15 percent of FICO score

A longer history of credit usage will raise your score; however, a high score can be achieved with a shorter history, as long as the credit report shows you have managed your credit responsibly.

Additional FICO Score Components

The following are two other key components that factor into your FICO score calculation:

4) Newly opened accounts -- 10 percent of FICO score

If your credit report shows newly opened accounts or recent account applications, this can factor into your score. If searching for a loan, avoid lowering your credit score by choosing a short time frame, such as 30 days, to do your loan shopping. FICO will regard multiple inquiries in a short time frame differently from many inquiries stretched out over time, which could have a negative impact on your score.

5) Other factors -- 10 percent of FICO score

There are other minor factors that can affect your score. For people with longer credit histories, a mix of different types of credit accounts such as credit cards, personal lines of credit, auto loans or a mortgage can slightly raise scores.

Free Reports

The Fair Credit Reporting Act gives individuals the right to get credit scores from the national credit reporting agencies. These agencies are allowed to charge a reasonable fee, usually about $8, to send you your score. Often, you will also receive information on how to improve your score.

According to the Federal Trade Commission website, consumers are entitled to get one free copy of their credit report from the three large national reporting agencies, Experian, Equifax and Transunion, once per year. There is a central website set up at Annualcreditreport.com that will assist you in getting your free reports. Many imposter sites will have offers of "free" reports, but will have a requirement for you to sign up for a paid service in order to get your report.

You may also order your free annual credit reports by phone at (877) 322-8228, or by completing the Annual Credit Report Request Form that can be completed after printing it from the website (see Resources).