Credit Scores Explained

What is a credit score and what is it used for?

Not all that many years ago, if you needed a loan you went to see the local banker. The banker would decide if you were credit-worthy based on what he knew about you – and maybe even what he knew about your parents and siblings. Your reputation was the deciding factor.

Now, if you go to the local bank you’ll be handed over to a loan officer, and even if that loan officer knows you well and likes you, you’ll get the loan based on your credit score. If your credit score is too low, you either won’t get the loan or you’ll pay an extremely high rate of interest.

That’s because, to a lender, a low score signifies that you’re a greater credit risk.

Most banks and other lending institutions use a FICO scoring formula, although several similar formulas are also in use. FICO stands for Fair Isaac Corporation – the company that developed the scoring system.

A credit score is a distillation of all the information in your credit report, plugged into a formula that calculates a single number to indicate your credit worthiness. Scores range from 300 to 850 – with most consumers falling into the 600’s and low 700’s. A score of 740 or higher should get you the best rates on any loan.

What factors go into the calculation?

  1. Your record of making payments  – making them on time every time gives you a higher score. Late payments, collections, bankruptcies, and foreclosures all lower your scores.
  2. The Way you use credit – if your credit cards are at or near their limit, you’re considered a greater risk.
  3. The age of your existing credit. If you’ve had and used credit for many years, you’re considered a safer risk than someone who is just starting out with credit usage.
  4. The number of inquiries on your file. If you have multiple inquiries from possible credit issuers over a short period of time, you’re considered to be a greater risk. Note, however, that inquiries from creditors for the purpose of soliciting your business do not count against you – nor do inquiries you make on your own credit file. Only inquiries resulting from a credit application count.
  5. Your mix of credit. Credit issuers like to see a mix of installment loans and revolving lines of credit. That somehow proves to them that you are able to handle multiple kinds of debt.

How lenders use the information does vary…

Two consumers with identical credit scores can be offered different interest rates for a similar purchase. That’s because these two people had different pluses and minuses that factored into their final scores – and certain things matter more to one type of lender than another.

Credit card issuers, for instance, will place more weight on your credit card payment history, while auto lenders are apt to focus on factors such as the down payment, your debt-to-income ratio, and your length of time on the job. They also look at your history regarding auto payments. To an auto lender, a missed car payment is more damaging than a missed credit card payment.

Mortgage lenders focus on your overall scores, and your score will determine the interest rate you’ll be offered.

However, mortgage lending standards have tightened considerably, and borrowers must once again meet several requirements. An underwriter will consider your down payment, your income, your length of time on the job, your overall debt-to-income ratio, and even the likelihood of you remaining on that job in the foreseeable future. High scores and a “stated income” are no longer enough to secure a loan.

If you’re planning a major purchase, get your scores now…

Credit reports reflect information that has been reported – and entered in a database. Often that information contains mistakes, and those mistakes can lower your scores.

So if you’re planning a major purchase, get your credit report and scores and check it for errors. They are not difficult to correct, but they do take time. In addition, your credit report will offer advice in the form of reasons why your score is lower than it might be. You can use that advice to make changes in the way you use your credit.

So don’t wait until you’re ready to make an offer on a home, drive off the lot in a new car, or apply for a credit card.

Get your free online credit report with scores right now from CreditScoreQuick.com. Or, go to www.annualcreditreport.com to request your free credit report from each of the bureaus. The report will be free, but you will pay a fee for the scores.

If you want to purchase your credit report and credit score, shop around first. The prices vary between the three credit bureaus. Here are the costs and contact information for ordering your own.

Credit report and credit score — a price comparison
Company Credit report Credit report
with credit score
Reports
from all three credit bureaus with score
Equifax

P.O. Box 740241

Atlanta, GA 30374

1-800-685-1111

$9 (Maximum.
Price varies by state and by credit circumstances.)
$14.95 $39.95
TransUnion

P.O. Box 1000

Chester, PA 19022

1-800-888-4213

$9.95 (Maximum.
Price varies by state and by credit circumstances.)
$14.95 $29.95
Experian

PO Box 2104

Allen, TX 75013

1-888-397-3742

$9 (Maximum.
Price varies by state and by credit circumstances.)
$14.00 $34.95
If you’ve recently been turned down for credit, you may be entitled to a free report. Contact the credit bureaus to find out more.

The prices, pulled from the Web sites, can change at any time. Visit the Web sites for a more complete description and pricing.



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Disclaimer: This information has been compiled and provided by CreditScoreQuick.com as an informational service to the public. While our goal is to provide information that will help consumers to manage their credit and debt, this information should not be considered legal advice. Such advice must be specific to the various circumstances of each person's situation, and the general information provided on these pages should not be used as a substitute for the advice of competent legal counsel.