What is a credit score? How is it calculated? More importantly, how does it affect you? These are a few of the questions that need to be answered to understand what such figures represent.
Your credit score is a numerical figure that reflects your capacity to pay off a loan. It's also called FICO score, an acronym for Fair Isaac Credit Organization, the entity behind the formulation on how to determine credit scores.
The higher your score, the better the chance of your loan getting approved. These digits will not only determine if you're a good financial risk but it will also establish the interest rate that will be attached to your request. Simple right? Well, not really. There are factors that contribute to the output that is your credit score.
Now, how on earth did these figures come about? A + B + X + Y + Z = credit score. 'A' which stands for payment history represent 35% of your credit score. This focuses on past debts and the time frame when it was settled. Every time you pay the monthly amount before the due date, your credit reports that you're on time. Same applies when you have zero balance every month. Although an overall good credit image may compensate for a couple of delayed payments.
The 'B' in the equation is the amounts due or debt ratio and it corresponds to approximately 30%. This is calculated by dividing the amount you owe to the credit available. As maintained by the credit bureaus, your score will get better every month if you maintain a debt ratio of less than 35% or owed $ 350 for a thousand dollar available credit. In here, having loans does not need mean that your credit score will drop in an instant. However, having a lot of loans and balances on multiple accounts will bring your score downhill. This scenario of having more than a few debts might lead the creditors to assume that you're a risk and that the possibility of you incurring default is high.
Another variable in the equation, the 'X' which stands for 15%, is the length of credit history. It appears that the longer the credit history, the better the score. It is due to the fact that the longer the history the better it is to weigh an individual's 'creditworthiness' and how well it manages his finances.
The last two, the new credit and types of credit in use, count as 10% each. With the former, your credit score diminishes by a margin for every credit application. Even inquiries are used as a basis for this particular aspect that compacts a credit score. Great risk will be posted if one opens several new accounts within the span of a year. As for the types of credit, having various types of credit increases one's score. A car loan, home loan, the list goes on. And if you are able to manage all these loans properly, then that's an additional point to your credit score.
A credit score ranges from 300 to 900. Those with excellent credit have a score of 720 and above, good credit belongs to the range of 660 to 719, a fair credit 620 to 659, and lastly, a poor or bad credit is 619 and below. With this said, having a bad credit does not mean the end of the world. Finding a loan may be hard but it's not impossible. Although you have to deal with more fees and steep interest rates.
If you want to have a copy of your credit score, there are credit bureaus which can furnish the same. But it is better to shop around before contacting any institution for the cost varies from one to another.