Your Credit Score: How Do They Get That Number?

In the world of credit each and every one of us has a credit score.  It's as if we're all playing some kind of game and somebody somewhere is keeping score. The problem is, nobody ever told us how and when we score points or how or why we loose points. They not only never told us the rules they also never told you how important the game is!

First, let’s make sure you know what a credit score is. It is actually a number from 300-800 which is a measure of risk of you defaulting or being delinquent in credit payments. Your credit score, also called a FICO Score, will determine whether or not you will receive credit, what interest rate you'll get, and how much credit you will receive. 90% of home loans are made only after a credit score is obtained. So it makes sense to know what your score is and how to improve it!

It’s interesting to know that many people don’t understand what impacts a credit score. If you suddenly get a better job and a $10,000 a year raise, you would think that would impact your credit score, wouldn’t you? It doesn’t. What if you win the lottery? Well, if you don’t use that windfall to pay down your debt, you still won’t impact your credit score. What impacts your credit score over time is how you use credit. If you pay off debt, you will impact your credit score.

The FICO credit score is actually derived with an extremely complex formula, so the average consumer will not be able to say to himself, “Well, if I pay off the Macy’s bill, it will raise my score by 50 points.” Unfortunately, it’s not that simple. Payment history accounts for about 35% of the FICO score. If you are paying on time, keep paying on time. If you are not, do whatever it takes to pay on time as it is the single biggest determinant in your FICO score.

How much you owe counts for about 30% of your FICO score. The more you owe when compared to your current credit limit, the lower your score. You would think that closing any account you don’t use would RAISE your score, but that’s not necessarily true since part of your FICO score is determined by a ratio of credit available to you and how much of that credit you are using. An exception might come about when you are applying for a mortgage loan. When I bought the home I live in now, I was stunned to find that there were 20+ credit accounts on my credit report which ALL had zero balances, and which I had not used in years. But because they represented potential spending, my lending institution recommended I close them, which I did.

The length of your credit history can impact your FICO score, too. If you have a long history of responsible credit use, you are more likely to be a good risk for continuing to pay your bills on time. But don’t despair; ANY length of time for which you can demonstrate responsible use of credit is in your favor.

What about the credit inquiries you, yourself, initiate? Well, about 10% of your score could be determined by applications for new credit. I’ve been in many stores which offer me credit cards at the check-out counter. But it’s best to resist these offers. What if you actually do need to initiate new credit? Such a need could arise when you are shopping for a home loan or a car loan. Try to limit your “search” to a tight time window, such as 30 days. Your inquiries are looked upon more favorably if it is clear that you were shopping for the best rate, and have chosen that one best rate.

Finally, there’s a miscellaneous category of about 10% of your score. If someone with a fairly lengthy credit history has a variety of credit experiences, that variety can actually add to the FICO score. These could be a combination of home loans, car loans, lines of credit, or credit cards. The key, once again, is to pay them consistently and on time.

So how do you get your FICO score? Well if you've read Free Credit Report, you know that your credit report is free. Unfortunately, your FICO score is not. Each of the three major credit reporting agencies will charge you extra for that to be included in the report. You of course have other options as well.  There are many different companies out there selling credit reporting information. Caution though, it is very much a "buyer beware" marketplace.  While the cheapest way is to get the free credit reports and electing to pay extra for your credit score, others might decide to spend a bit more for addition help in deciphering the reports, as they tend to be a bit intimidating to the average consumer. If that sound like you we suggest you visit myfico. They offer a product from the very popular financial advisor Suze Orman that we recommend very highly. It includes credit reports from all three reporting agencies, your FICO score, and automated help in correcting, understanding, and improving your Credit Score. As of early 2006 pricing it sells for $49.95 and is well worth the price. 

 Should you wish to contact the three large agencies individually, they are www.experian.com, www.equifax.com, and www.transunion.com.