What is three-digits and follows you wherever you go? That is right… credit scores! In this article, we will lay out what a credit score is, how your score is calculated and what you can do to improve your score today.
Q. What is your credit score?
Your credit score is essentially a metric to determine how trustworthy you are when it comes to paying back loans or any other form of debt. Similar to actual trust, it is something that can take a while to gain and can be lost in the blink of an eye. If you have a higher credit score, you will be more likely to qualify for low interest loans when stacked up against someone with a lower credit score.
Fair Isaac Corporation (FICO) was the first company (1989) to develop a three-digit credit score. They would create the score based on a detailed report of your history when paying back loans; scores traditionally range from 350-800. Vantagescore has been another competitor in this fairly new market, but we will cover the differences between FICO and Vantagescore in another post.
FICO sends its formula for each and every person to three companies: Equifax, Experian and Transunion, and they also utilize their own information to create a credit score. In other words, every person has 3 separate credit scores usually with a deviance of under 50 points. You are allowed to have one free credit report from each of these three companies annually.
Q. How is your score calculated?
Understanding the knit and grit of the score would be enough to put a seasoned economist to bed. There are many variables in each score which are difficult to understand and quite mundane, but here is a simplified way of comprehending the calculation.
35% payment history- How often do you pay late, if at all?
30% amount owed- How much do you owe?
15% length of history- How long has an account been in your possession?
10% new credit- How often do you apply for new credit?
10% types of credit used- What is the quality of credit being used?
Are you paying off debt from a department store credit card or a national bank’s credit card?
Q. How can I improve my credit?
FICO has provided tips on their website corresponding with each of the 5 breakdowns (payment history, amount owed, etc.)
35% payment history
● Pay your bills on time!!!!
● Understand that because you pay off debt it will still be a black mark on your payment history, and may stay there for up to 7 years
● If you miss a payment, make the payment up asap 30% amount owed
● Pay off debt rather than moving it to other credit accounts
● Don’t close credit cards as a short term means to raise your score 15% length of history
● Do not open up new accounts too rapidly especially if you’ve been managing credit for only a short period of time 10% new credit
● It is okay to check your credit and see what you owe 10% types of credit used
● Closing an account does not make it go away
● Have credit cards, but manage them responsibly