Credit Score Breakdown
A credit score is determined much like a grade in school. Consider how a teacher calculates grades by taking scores from tests, homework, attendance and anything else they want to use, weighing each one according to importance to come up with a final, single-number score. It's the same for a credit score. But instead of using the scores from pop quizzes and papers, it uses the information in your credit report.
The number ranges from 300 to 850. Although the exact formula for calculating the score is proprietary information and owned by Fair Isaac, here's an approximate breakdown of how it is determined:
- 35 percent of the score is based on your payment history.
This makes sense since one of the primary reasons a lender wants to see the
score is to find out if (and how promptly) you pay your bills. The score is
affected by how many bills have been paid late, how many were sent out for
collection and any bankruptcies. When these things happened also comes into
play. The more recent, the worse it will be for your overall score.
- 30 percent of the score is based on outstanding debt. How
much do you owe on car or home loans? How many credit cards do you have that are
at their credit limits? The more cards you have at their limits, the lower your
score will be. The rule of thumb is to keep your card balances at 25 percent or
less of their limits.
- 15 percent of the score is based on the length of time
you've had credit. The longer you've had established credit, the better it is
for your overall credit score. Why? Because more information about your past
payment history gives a more accurate prediction of your future actions.
- 10 percent of the score is based on new credit. Opening new
credit accounts will negatively affect your score for a short time. This
category also penalizes hard inquiries on your credit in the
past year. Hard inquiries are those you've given lenders permission for, as
opposed to soft inquiries, which include looking at your own
score and have no effect on the score. However, the score interprets several
hard inquiries within a short amount of time as one to account for the way
people shop around for the best deals on a loan.
- 10 percent of the score is based on the types of credit you currently have. It will help your score to show that you have had experience with several different kinds of credit accounts, such as revolving credit accounts and installment loans.
When it's all said and done, just how important is this magic number? And what does it mean for your interest rates?
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