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Understanding Your Credit
The Basics of Credit Scores
By Roger Wohlner
CERTIFIED FINANCIAL PLANNER™ Practioner, Asset Strategy Consultants
When lenders evaluate a credit application, they usually request both your credit report and your credit score, which is a mathematical calculation based on information on your credit report. The score is intended to rate your credit risk, although other factors, such as your income, length of employment, and years resided in your home, are also considered.
Credit scores are often referred to as FICO scores, since they are produced from software developed by Fair, Isaac and Company (FICO). While all of the major credit reporting agencies use FICO scores, your score from each agency can differ because information on your credit report differs by agency.
FICO scores range from 300 to 850, with higher scores indicating lower levels of credit risk. A score over 620 is considered creditworthy, while a score of 670 or higher is considered excellent. Often, the interest rate offered by lenders will be tied to your FICO score, with a higher score receiving a lower interest rate. The major factors affecting your FICO score include:
Payment track record - This is the largest component of your score, comprising 35% of the total. Lenders like to see that you've paid all your bills on time for the past seven years.
Outstanding credit - Comprising 30% of your score, this is a measure of your credit utilization ratio, or how much of your available credit is outstanding.
Credit history - This relates to how long a credit history you have with various lenders and accounts for 15% of your score.
Credit inquiries - Approximately 10% of your score is based on the number of credit inquiries by lenders in recent months.
Debt mix - The remaining 10% of your score is based on whether you have incurred and made timely payments on a variety of types of debt, such as credit card debt, a car loan, or a mortgage.
Typically, scores of 720 and above receive the best deals on interest rates. Based on the way the FICO score is calculated, there are strategies to improve your score if you're not at that level:
Make sure to pay all your bills on time. Check your credit report to see if there are any late notices. If so, and you have a good credit record, ask the lender to remove the notice.
Reduce your credit utilization ratio. You receive a better score when your outstanding debt as a percentage of your available debt is lower. Make sure your credit utilization never goes over 50%. If you can't pay down your debt, ask your lender to increase your available credit. This will have the same result as paying down your debt, but make sure you aren't tempted to use that additional credit.
Don't close every credit card you don't use. This has the result of increasing your credit utilization ratio because you have less available debt. However, if you have too many credit cards, typically over five, close the newest ones. Too many credit cards make lenders uneasy.
Minimize requests for additional credit. Inquiries regarding additional debt appear in your credit file and hurt your credit score.
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