A consumers credit score is one of the most important items of consideration a lender will evaluate when reviewing a loan application. Building a good credit score and maintaining that credit score is one of the most important things a consumer can do to create a strong financial profile. Most consumers find that what makes up one’s credit score is a mystery to them so in the paragraphs below we will try to share some of the details of what makes up our credit scores.
A consumers credit score can be thought of as a three-digit number generated by a mathematical algorithm using information from one’s credit report. The credit score is designed to predict risk, specifically the likelihood that a consumer will pay back their creditors on time or become delinquent on your credit obligations. Credit scores are also sometimes referred to as FICO scores and they range from 300 to 850, where the higher the number indicates the lower the risk to a financial institution.
How is Credit Score Calculated?
A consumer has three credit scores, one from each of the three major credit bureaus – Equifax, Experian, and TransUnion. When considering the credit history of a potential home buyer, mortgage lenders will use the middle score of the three provided on one’s credit report.
Credit scores are calculated using data from one’s credit report. The credit data that is used to calculate one’s credit score and how much of that data is used is determined by the companies that own and run the credit scoring companies. Lets take a look now at the categories that make up a credit score.
What Categories make up my Credit Score?
There are five key criteria commonly evaluated to determine one’s credit score. According to the folks at myFICO.com these five categories will have a different level of importance from one consumer to another based on the differences in each of our credit histories. For example, people who have not been using credit long will be scored differently than those with a longer credit history. And for some people, one category may have a larger impact on their credit history than it does for someone with a much different credit history.
These are the categories developed by FICO that help to determine our credit score:
* Payment history (35 percent): making on-time payments has the most positive impact on your score.
* Amounts owed (30 percent): lenders like to see a consumer’s credit utilization at 30% or less of total available credit. Having large card balances or being near your credit limit on multiple accounts can negatively impact your score.
* Length of Credit History (15 percent): lenders want to see you can responsibly manage credit accounts over time. Try to get one or two credit cards that you like and keep them for the “long-haul” so the age of your oldest account is long and you build up your length of credit history.
* Types of Credit Accounts (10 percent): the score will consider your mix of credit cards, installment accounts, retailer cards, and mortgage loans if any. A balanced mix of different types of credit (i.e. – auto loan, credit cards, student loans, or mortgage) can help improve your score.
* New Credit (10 percent): data shows that opening several new credit accounts in a short period of time represents a greater risk for lenders, especially for consumers who don’t have a long credit history.
What is the Highest Credit Score Possible?
There are several versions of the FICO score and for most of the FICO credit score versions commonly used for lending purposes the highest credit score possible is an 850. As a loan officer I have pulled more than 1,000 credit reports in my career and I can honestly say that I have never seen an 850 credit score. However, I can say that I have seen several scores that were close to that, just not at the 850 level.
This might be a good time to review the range of credit scores to define the lowest credit score range up to the highest. FICO as explained has a number of credit score versions but on the ones that matter the range generally is 300 to 850. And the explanation of each of these credit ranges look like this
Poor 300 – 579
Fair 580 – 669
Good 670 – 739
Very Good 740 – 799
Excellent 800 – 850
To improve your credit score, it’s important to understand that 65% of your credit score is made up of something that you can control on a daily or monthly basis. Your payment history and amounts owned make up 65% of your credit score and you can improve on both every month.
For payment history I advise clients to pay bills online and set them up as automatic payments, so every payment is made on time each month. Late payments can be quite damaging to one’s credit score and it takes a long time to recover from the credit score drop that will happen from having any sort of late payment reporting.
Amounts owed is another way of saying credit utilization and this is something very easily controlled by the credit user. Minimize any unnecessary spending on items that are not essential and keep credit card balances low so your credit utilization is under 30% on each credit card.
It helps to know what goes into one’s credit score. When you have an understanding of how your credit score is calculated I think that makes all the difference in the world to maintaining a positive credit history. Set goals each month to pay down credit balances, pay every creditor on time, minimize any credit inquiries, and don’t open up any new credit unless you are still in the credit building mode.
If you want to actively manage and monitor your credit, we recommend one of the credit monitoring services offered by each of the three credit bureaus. Their data, while not entirely accurate, may offer the clearest window into your credit compared to the monitoring provided by non-credit bureau vendors.
Now that you have learned all about what is a credit score, the next step is to put a plan in place to either establish new credit, or to re-establish your credit after a past credit event that may have hurt your credit score. Building or re-establishing credit takes time so be patient and stay the course by following the plan you put together. To learn more about how to build your credit, we have a detailed article about this topic HERE.
Our final suggestion when managing your credit is to stay active in the process as it is on-going. We wrote an article about how to check on your credit and how often you should check your credit and you can read that article HERE. You want to make sure the accounts being reported by the credit bureaus are actually your accounts and they are being reported accurately.
For example, if an account that you have is current and “paid as agreed”, you want to be certain that your accounts are reported as such and none of your accounts have any errors that might cause them to be reported as a collection account. If you actively manage your credit then you can watch for things like this and actively correct any errors like these should they arise. Good luck!
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