Credit rating scores explained

Written by barb nefer
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Credit rating scores explained
(Credit card accounts affect your credit rating score.)

Credit rating scores are mysterious to many people. You may know that your credit score is a three-digit number that directly affects your ability to get credit cards and loans. However, you may not know how your credit score is actually calculated or if you can do anything to affect it. A credit-rating score isn't really as confusing as it seems. The factors that affect it are straightforward, and you have some control over most of them.

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Definition

A credit score is a three-digit number that is compiled using information from a consumer's credit report. The most commonly used credit score is the FICO score, which is calculated based on a formula developed by Fair Isaac Corp. (FICO). Although the exact formula is proprietary, FICO gives general information on the factors it considers and their relative weight.

Use

A credit score is a quick indicator of your creditworthiness. It is used by mortgage lenders, credit card companies and financial institutions to make decisions on whether to give you a loan or allow you to open an account. Your FICO score also influences the interest rate you will pay. If you have a low score, lenders may penalise you by charging a higher interest rate to compensate them for a higher perceived risk.

Calculation

A credit score is calculated based on several factors. According to FICO, the most important factors are the consumer's payment history and the amounts he owes on his accounts. Together, these two factors make up 65 per cent of the credit score. Other factors with a lesser influence include how long a consumer has had credit accounts, the types of loans and accounts he holds, and the number of recently opened accounts.

Range

The highest possible credit score under the FICO system is 850. Any score between 850 and 720 is considered to be excellent. Consumers within this range can readily get credit card accounts and loans at favourable interest rates. Scores between 719 and 600 still qualify for credit, although the terms may not be as favourable. Lower scores make it progressively more difficult to get credit and put consumers in a high-risk category where they must pay an interest penalty.

Influence

Consumers can influence their credit scores by focusing on the factors that have the most influence. Making on-time payments and maintaining a reasonable amount of credit are the two most important ways a person can improve his score. The on-time payments must be made consistently over a period of many months to have a noticeable effect.

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