Credit scores are formulated from the financial information on your credit report. While the weights of the items vary by whose scoring model you are using, things such as payment history, accumulation of debt, mix of types of debt, length of credit history, and balance to credit ratios bear weight when it comes to your credit score.
In some scoring models, your revolving credit can have among the largest impact on your credit score. Revolving credit would be credit cards such as store cards and bank cards. In order for the impact to be positive, it is important to keep balances low – less than 30% of the credit limit. While the average percentage is sufficient to improve your score, it is better not to have any card balance above the 30% credit limit.
As important as revolving credit, is how you pay that credit. Paying your loans and credit cards on time will improve your credit score slightly, however paying one bill late can drop your credit score 20 points or more. A drop of 20 points or more may take you months or even years to recover from depending on the other factors affecting your credit score.
The length of credit history has the next biggest impact on your credit score. Length of time a credit item has been open applies to both positive and negative items on your credit report. A negative item that has been open for 5 years and is reported on your credit report has a positive impact on the average age of accounts. Removing such an item before it falls off of the report, could have a negative impact on your credit score as the age of this account counters the newer accounts that may be reported on your credit report.
Installment loans, such as car loans, mortgage loans, student loans, and personal loans, add to the mix of credit. While revolving credit holds a larger piece of the credit score pie, installment loans are important as they demonstrate your ability to fulfill different repayment requirements. Having both revolving and installment loans on your credit file improve your credit score.
Interest rates and insurance premiums may be a casualty of your “good” credit score. When your credit score is 640+ is it high enough to qualify for a mortgage, but it still may be costing you when it comes it comes to the interest rates you pay on your credit cards, the interest you pay for your house, the interest rates you pay for your car, and even your insurance rates.
Credit card companies offer the lowest interest rates to the applicants with the best credit. Good credit might get you a credit card offer, but the rates will not be the lowest available on that card. They look at what your current balances are in relation to the credit limits. The lower your balances across all current credit, the more favorable the interest rates you are offered.
When you apply for a loan, whether a car loan or a mortgage, underwriters look at your credit history to determine the risk of you paying back the money being borrowed. While both a car and a house are secured loans, they represent a large sum of money. The higher your credit score, the lower your interest rate.
In most states, insurance companies determine your insurance premiums by certain items on your credit report. An experiment by insurance companies in the early 1990s, along with the credit bureau behind FICO found a correlation between certain credit items and your likelihood of filing a claim on your insurance. While such a correlation is not always accurate, it was accurate enough for the practice to become industry standard in most states. Three states, California, Hawaii, and Massachusetts, do not permit the practice of using your credit score to set your premiums, the remaining states still do. In the states that allow such decisions to affect your insurance premiums, insurance companies are not required to tell you what information they use from your credit report to determine whether you are a higher risk of making a claim.
Credit scores are three-digit numbers that represent your credit-worthiness according to a given algorithm. Equifax, one of the three major credit bureaus, uses what is called a Beacon Score. Experian, another of the three credit bureaus, uses what is called a Vantage Score. Trans Union, the third credit bureau, uses what is called Credit Vision. In addition to their individual scoring models, each of the three credit bureaus produce a FICO score.
Equifax’s Beacon Scores are used by some creditors to determine your credit-worthiness. There are several Beacon Scores depending on which application the score is used for. If a bank or credit union is looking to extend you credit in the form of a credit card, they would not use the same Beacon Score as they would for a car or mortgage. Equifax also offers a score to those who have a credit file with them, by their own disclaimer, this number is not the same one that is used by creditors to extend you credit and is for informational purposes only.
Likewise, Experian’s Vantage Scores may be used to determine your credit-worthiness. There are several Vantage scores with both Equifax and Experian having at least 16 different scoring models. Each scoring model has a different application. In addition to that, Experian produces another score for consumers-only, this credit score is called a Plus score.
Trans Union’s credit scoring model is called Credit Vision and generates at least 21 different scores for various applications. While each of the credit scores generated serves a purpose, it does make it difficult to be able to know your true credit-worthiness.
While each of the credit bureaus produce their own scoring models, they also provide the information to produce another credit score called a FICO score. FICO scores are produced by the software created by Fair Isaac Corporation. Each of the three credit bureaus produce a series of FICO scores dependent on the application it is used for.
Each of these credit scores range from 300 at the lowest to 850 at the highest.
When a creditor asks you to estimate your credit and you tell them you have bad credit, the creditor expects your credit to be in the range of 550 or less. A score this low will make it difficult to secure additional credit. This is also referred to as poor credit. You are deemed to be too much of a credit risk to extend credit to.
Subprime is defined as a credit score between 550 and 620. While it may be possible to obtain credit with a credit score this low, any credit obtained will be more expensive in the long run. Credit obtained while your score is in this “subprime range” is often at a higher interest rate as well as other terms that are more to the advantage of the credit lender than the credit borrower.
It is not until your credit reaches the 620 to 680 range that you become eligible for “prime rates.” At this level, you are likely to have credit extended to you, however the interest rates you will be offered are still not the best, causing your purchase to cost you a little more over the long run. A home loan issued to someone with this level of credit may be sold to Fannie Mae or Freddie Mac.
Once credit reaches 680 to 740 it is finally considered “good credit”. Good credit increases the likelihood of your loan being approved with terms that a bit more advantageous to you, the credit borrower. Both the “average FICO score” (687) and the “median FICO score” (723) are in this range. Having good credit can save you as much as 4% on a car loan.
The highest credit level is considered “excellent credit” and the range is between 740 and 850. It is easy to obtain credit at this level. Insurance premiums that are influenced by items on your credit report are lower for people whose credit is in this range. Once your credit score is high enough to be in this group, you are offered the best interest rates and find that you have no problem qualifying for credit.
Interest rates and insurance premiums are often lower for those with excellent credit. While good credit will give you the ability to get a car loan, the rates may be higher than you would pay if you had excellent credit. In addition, your “good” credit may be costing you more in insurance premiums in most states, despite a good driving history.
Algorithms for credit scores weigh several financial factors to determine your credit-worthiness in multiple facets of your life. From bank accounts to mortgages and everything in between, your ability to obtain credit, get a job, and obtain insurance is determined by one of these three-digit scores generated by a series of complex calculations, known as algorithms. Age of credit, types of credit, payment history, and balance to credit ratios are all weighed in to your credit score. While it is the most important three-digit number in your financial life, it is not just one number, there are several different ones based on the application. Paying bills on time, having a variety of accounts, having mature accounts, and having low balances are the best way to improve your credit score.
Free Credit Score
Free credit scores can be obtained from many different locations. These free credit scores are updated weekly or monthly depending on the source. Often times the free credit score is not very accurate. Many credit cards offer a free credit score as one of the benefits of being a card holder. There are also other websites that offer free credit scores. The free credit scores that are offered through the websites are for informational purposes only and are not generally accurate to the scores that credit lenders use.
Some credit card companies offer a free credit score to their card members. This is a perk that is done so that their card members can monitor their credit. Capitol One uses what they call Credit-wise. The credit bureau used to generate the free credit score on Credit-wise is TransUnion. Unlike with the free credit scores offered by other credit card companies, Discover Card offers the FICO 8 from TransUnion to anyone who registered at their website.
Multiple other websites provide consumers with a free credit score. NerdWallet, Credit Sesame, and Credit Karma are three such sites. The free scores that these three sites offer are based on either a consumer’s TransUnion or Equifax credit file. The free credit scores that are offered by each of these sites require registration. None of the free scores are accurate to the score a creditor uses to extend credit.
In addition to the sites that offer free credit scores, several other sites offer low cost credit scores as an introductory offer on credit monitoring. Credit monitoring allows consumers to access updated credit reports for a monthly fee. These fee-based programs are offered by many different websites as well as each of the three credit bureaus and FICO.com.
No-cost credit scores do not count as a “hard inquiry” on your credit report, as such it does not impact a consumer’s credit score. “Soft inquiries” are only seen by the consumer when the consumer pulls their own credit report. As a free credit score is not the same as the one used for extending credit, it should be used for informational or educational purposes only.
Free credit scores can be obtained from multiple sources. Many credit card companies offer a free credit score as a perk of being a card holder. Several on-line websites also offer free credit score for registering at their site. In addition to these free credit scores there are fee-based credit monitoring services that produce credit scores that are updated on a monthly or weekly basis.