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Understanding Your Credit Score & How Credit Scoring Works

By on September 19, 2014 in Credit

Your credit scores are compiled by the 3 major credit reporting agencies: Experian, Equifax and Trans Union. These credit reporting agencies act as databases storing information on every aspect of your life. Your employers, landlords and creditors use these databases to help them make decisions regarding you as an employee, renter or creditor. Yes, a bad credit history could mean being denied a job or apartment just as easy as a great credit score could mean a lower rate on your car insurance. In return for access to your credit profile, companies agree to provide data about all of their customers back to those very same credit agencies. Employment history, place of residence and payment history are just some of the things reported and stored using your social security number.

Almost every aspect of our life is affected by our credit score. From opening a new credit card, to renting an apartment and even the rate you pay on some of your insurances can be affected by your credit history. The reality is many of us have no idea what is on our credit report and even fewer truly understand how our score is calculated. Having a better understanding of how your credit works can be very beneficial in helping you avoid potential problems down the road.

What does your credit score mean?

So what is actually being reflected by your credit score? Your credit score is a representation of your credit worthiness. The representation of credit worthiness is shown in the form of a score called FICO score. The three major credit reporting agenesis – Experian, TransUnion and Equifax all have their own name for FICO score.

  • Equifax: Beacon Score through their ScorePower product
  • Experian: PLUS score
  • TransUnion: EMPIRICA

One thing you will quickly see when looking at your credit report is that the score from each of the three bureaus will be different. This is due to the fact that each company calculates the FICO score slightly differently.

On March 14th 2006, the three major credit bureaus (Equifax, Experian and TransUnion) released their own credit rating product names VantageScore. The VantageScore was created in an effort to compete with the FICO score produced by FICO.

How is your credit score created?

A number of factors come into play when determining your credit score. It is important to understand that different parts of your credit report can have a greater effect on your score than others. This is because some data is looked at with more importance than others. Here is a breakdown of the major pieces of data and the respective weight credit bureaus place on each.

  • Payment History: Your payment history accounts for 35% of your total score. The fact that payment history makes up such a large part of your score makes paying your bills on time extremely important. The credit agencies, when considering payment history, look a recency, frequency and severity. Payment history in the last six months will be given great importance than the past two year which will be given greater important than anything older than 2 years. This means that while you may have had some late payments in the past. Getting a handle on your bills and showing a good payment history can have a positive effect on your score in a relatively short period of time.
  • Amounts Owned: Next in importance, revolving balances account for 30% of your total score. As you can see payment history and revolving balances are huge factors on your credit score accounting for 65% of your score. A high credit balance may signal an increased risk and therefore lead to a lowering of your score. It is important to pay down or off your credit card balances as quickly as possible.
  • Length of Credit History: Your credit history makes up 15% of your score. Generally speaking, a longer credit history will increase your score. However, this does not mean that having a relatively new credit history automatically means a low credit score. Many people with new credit histories find themselves with high credit scores because other areas of their credit factor well. So how is the length of your credit history looked at when calculating your credit score? Some of the factors in your credit history that affect a score include:
    • How long ago your accounts were established:
      • Age of oldest account
      • Age of newest account
      • Average age of all accounts
    • How long ago you last used specific accounts
    • The age of certain credit accounts
  • Type of Credit: Making up 10% of your credit score is the type of credit in use. Both open and closed accounts will be looked at with regards to the types of credit you have. The different types of credit accounts and the number of each type you have or had will affect your score. So what types of credit are there? Simply speaking there is revolving credit such as credit cards and retail accounts, installment loans such as a car loan, finance company accounts like the TV or furniture you buy now and have a year to pay interest free and finally mortgage loans.
  • New Credit: The final 10% of your credit score calculation is derived from new activity. History shows that opening several accounts in a relative short period of time equates to a greater credit risk. This is particularly true for people with short credit histories. An increased number of hard inquiries can also have a negative effect on your credit score. If you are shopping for a low rate on a car loan try to keep shop rates in a 14 day window or less. If you are looking for a new mortgage the window of shopping rates should be less than 45 days. This will help keep all the credit pulls by different lenders seeming like separate inquiries.

Yes, trying to figure out what your credit score should be is virtually impossible. However, if you pay your bills on time, pay off credit cards every month (if possible), open only the account you need and don’t over extend yourself you should not find it hard to maintain a healthy credit score. Should you fall on hard times and find yourself in a financial mess don’t fret. Take some time to reassess where you are at and implement an action plan to get you back on track. With a little work and some patience, you can find yourself back in your credits good graces. Finally, take the time to understand where you are today with your credit history. Mistakes happen and the last thing you want to be is surprised by mistakes on your credit report. Once a year you are able to get a free copy of your credit report by visiting www.annualcreditreport.com.

About the Author

About the Author: Husband, father, tech junkie and sports enthusiast. I have owned and operated ezratequotes.com as well as a number of others sites since 2005. .

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