Unlocking the mystery of credit scores
Q : I just applied for a mortgage and found out that my credit score is much lower than I thought. What makes up a credit score?
A: One of the worst times to find out that your credit score is lower than you'd estimated is when you're sitting across from a mortgage lender. But you're not alone in guessing wrong.
In a recent survey from LivingWithBadCredit.com, an educational Web site, more than three-fourths of people surveyed reported not knowing their credit scores within a 200-point range. Nearly half of them had never checked their own credit report and score, while 17 percent hadn't checked in several years.
Knowing your credit score is the first step in improving your credit standing. But unlocking the mystery behind credit score calculations is somewhat more elusive.
The most commonly used credit score is the Fair Isaac Corp. score, or the FICO score. The score runs from 300 to 850. A score above 750 is generally considered good and a score below 620 is considered risky. The range between the two depends on the lender looking at the score.
FICO uses information from your credit report, which is compiled by three major credit reporting agencies, to calculate your credit score.
FICO looks at five categories, each weighed differently, to determine your score.
Payment history: This category is the most crucial and accounts for 35 percent of your total credit score.
FICO monitors both revolving loans like credit cards as well as installment loans like student loans or mortgages. Making consistent, timely payments is one of the best ways to improve your credit score overall.
Debt amounts: This category makes up 30 percent of your score and deals with your total outstanding debt.
In this category, revolving accounts weigh more. Unlike installment loans where the debt amount is already determined, revolving accounts allow a person to borrow as much or as little as she wants up to a limit.
To insure a higher credit score, keep credit card balances low. The amount you owe shouldn't exceed 30 percent of your credit limits, recommended Robert Anderson, co-founder of Focus Inc., which runs LivingWithBadCredit.com.
Length of credit history: FICO looks at the amount of time each account has been open and the amount of time since the account's last action. This makes up 15 percent of your total score. More credit history paints a more accurate picture of long-term financial behavior.
New credit and credit mix: Each of these make up 10 percent of your score.
Even if you're new to credit, don't open too many accounts at once. Doing so could indicate that you're in financial straits and need access to a lot of credit. Only take on new credit when you absolutely need it or when it makes financial sense.
To avoid unpleasant surprises when applying for a loan, check your credit report and your credit score at least once a year.
Every person is entitled to a free credit report annually from one of the three credit reporting agencies, although it costs a minimal amount to receive a credit score.
Summary of an article taken from mcall.com.