Credit Score
A person’s credit score is a number (represented by three digits) that is created through the use of a mathematical formula. This formula creates a person’s score by using details of that particular person’s credit report, and is specifically utilized to determine what level of risk a person is at for becoming financially negligent with their credit during the two years after the credit score has been determined. Financial institutions such as a credit union or a bank or credit card company often take a person’s credit score into serious consideration when evaluating whether to lend money to that person. Furthermore, depending on if you have a good or poor credit score, it can either mean you’ve been granted or denied access to credit, been given an elevated or small interest rate, as well as being approved for housing rental and/or a deposit-free utility connection. Also, the rampant availability and use of the credit score has enabled people wider and cheaper access to various sources of credit.
Every citizen of the United States, thanks to a newly-implemented federal law, is entitled to a free-of-charge credit score report. There are three agencies which specialize in providing credit reports: Equifax, Experian, and TransUnion. Once you have your free credit score report, you’ll see that your credit score is split into four components. You may be confused as to how to make sense of the large amount of information and numbers presented in the report. Thus, to help make sense out of a credit score, as an example, the following breakdown of a credit report may be useful:
Identity Information: This section of the report is straightforward, and includes your name, address, phone number, Social Security number, date of birth, drivers license number, etc. Make sure this information is correct and up to date.
Credit History: This section is the list of all your credit accounts, and includes items such as the form of credit (e.g. mortgage, credit card), amount of the loan, amount you still owe, monthly payment amount, the reliability of your payments.
Public Records: This includes your financial information such as any bankruptcies, tax issues, etc. It’s best if this section of your score report is blank.
Inquiries: This is simply a list of people or organizations, etc., who have requested to see your credit score.
FICO
When it comes to credit scores, the most popular and most-used type of score is called the FICO score, which is determined via a secret mathematical formula using information from a person’s credit history. The higher a FICO score, the better the credit worthiness. The FICO score is made up of 5 sections. Section one makes up about 35% of the score, and involves the person’s payment history (e.g. any past due payments or how many payments made on time). The second section accounts for 30%, and tells the amount that you still owe on all of your credit accounts. This section takes into consideration how much credit you’re using on all your accounts. The third section looks at the amount of time you’ve been using credit, and makes up 15% of your score (e.g. when you began the credit account and when the last time you used the account). The fourth, making up 10%, lists all the various types of credit you have (credit card, car loan, mortgage, bank loan, etc.). Finally, the last section, making up the remaining 10%, lists how often you have searched out new types of credit, and includes simple inquiries as well as successfully opened accounts.
Next-Gen Score
Another version of the FICO score is what is known as the Next-Gen credit score. This score determines a person’s potential level of risk as a credit customer, and is basically a deeper and more predictive level of credit scoring than the classic FICO score. For example, against the regular FICO scoring system, the Next-Gen scoring formula can predict 23% more “bad-payers” (people who are at the lower end of credit scores and with many accounts of $3000 or more). Also, in terms of the subprime market (e.g. people with past serious credit issues or those with credit write-offs by their lenders) a Next Gen score can increase the amount of approved credit loans by as much as 10% over traditional FICO scoring. Furthermore, for lenders in the bank card, auto, home, and retail sectors, when using the Next Gen scoring system, a lowering of poor rates of as much as 20% is highly possible
Conclusion
Overall, for the average consumer and user of credit, the best defense against a poor (low) credit score is preventive maintenance. Several ways exist to help you keep your credit score as high as possible. First of all, educate yourself. Do your research and understand what a credit score is and what is involved in the determination of your credit score. Secondly, be sure to pay all of your bills as they are due. Thirdly, try to maintain a low balance on your credit cards. The higher the balance, the lower your score will be. Also, once you’ve paid off a credit card, do not close that account. If a credit card account is closed, it will automatically be invisible on your credit report, thus affecting your score. Having the account open but paid in full will increase your score.