To some people, the words credit score elicit the same heart-pounding reaction as root canal. For these and many other individuals, credit scores have prohibited them from buying a car, purchasing a house, obtaining a credit card or even landing a job. Despite the importance of this number, most people do not completely understand how a credit score is calculated and how it changes day-to-day.
A credit score is simply a number which corresponds with a person’s credit worthiness. A higher score corresponds with a greater statistical likelihood of that person paying his or her debts while a lower score indicates a higher propensity to default on financial obligations. FICO, the most widely used credit score published by the FICO company, ranges from a low of 300 to a high of 850.
A FICO score, like any other credit score, is derived from a person’s credit report. In the U.S., there are three major credit reporting companies: Experian, TransUnion and Equifax. These companies are massive data collection entities, which gather and then report information regarding a consumer’s borrowing habits and history of paying debt obligations. The companies record how much credit card debt, auto loans, mortgages or any other credit a person has and whether he or she repays those loans on time. These reporting companies get their information from a variety of sources including banks, other lenders, debt collection agencies, public records or even utility companies.
— Eric Bretan, the co- owner of Rick’s Estate & Jewelry Buyers in Punta Gorda, was a senior derivatives marketer and investment banker for more than 15 years at several global banks.
Once FICO receives a person’s credit information, it then uses this data to calculate his or her FICO score. The number is based on five factors. The first and most important is an individual’s payment history. This represents 35% of the overall FICO score. Any missed payments, bankruptcies, foreclosures, late payments or legal judgments against a person will negatively affect this part of the FICO score. Statistics show that past credit issues are a strong indicator of credit difficulties in the future.
The second most important component of a FICO score is a person’s debt burden, which corresponds to 30% of a person’s score. There are a number of metrics which are examined in this category such as how many loans or other obligations a person has. Obviously, a greater number of debts would translate into a greater likelihood of not being able to pay some back. Another factor would be the debtto limit ratio. If a person maxed out every credit card that he had, that would potentially indicate that the person is having financial difficulties compared to a person who has a large limit but is carrying a small balance.
The third aspect of a FICO score is the length of the individual’s credit history. A person who has had a long history of responsible debt management will be looked upon more favorably compared to someone who opened his first credit card last week. For the latter, there is no history to judge the person’s reliability in paying back debt. This component makes up 15% of a FICO score.
The two final factors of a FICO score, representing 10% each, are the types of debt a person has and credit searches. For the former, a person who is able to balance many different types of debt obligations including a mortgage, car loan and a credit card will be seen more favorably than a person who just has a mortgage. And many credit searches can indicate that a person is about to take on new, unknown debt, which can be seen as potentially negative. However, this is a more minor factor than people realize as FICO ignores credit searches after a year, and if a person applies for credit at a number of lenders within a short time frame, FICO counts this as one search.
The primary misconception regarding a credit score is what is not analyzed as part of calculating the score. For example, a person’s income has no bearing on a credit score. Nor do the individual’s age or employment status.
Once a person understands how a credit score is calculated, boosting a lagging score becomes a little easier. Clearly the most important thing to do is to pay debts on time. But beyond this, a no-cost way to increase a FICO score is to increase a credit card limit but keep the balance the same. This will improve a person’s debtto limit ratio. Another way is to obtain a free copy of one’s credit report from www.annualcreditreport.com. There may be errors in a person’s report that are negatively affecting the score without the consumer even knowing about it. ¦
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March 25, 2020 at 12:30PM
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Questions about your credit score? Here's how it's figured - Florida Weekly
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