Creditors today rely on a consumer’s credit score in the determination of whether or not to extend new credit. Below, we provide key information on how creditors and credit reporting agencies provide a credit score based on the various factors included with your credit file.
What is a Credit Score?
A credit score is a numerical interpretation of a consumer’s ability to repay debts in a timely fashion. Credit scores indicate to future credits a risk assessment based on your patterns of the repayment of previous or current debts. In essence, credit scores advise companies of the likelihood that you will or will not default on a new loan.
To calculate your credit score, companies gather information on your credit history with regard to timeliness of payments, accounts open and defaults against you. Companies then compare this information to others with similar credit profiles as a way of determining your creditworthiness. Consumers with high credit scores are considered a relatively low risk for default, while those with lower scores offer a higher risk of default.
Companies That Rely On Credit Scores
Lenders, car dealers, insurance companies and credit card companies all rely on a consumer’s credit score in order to determine whether or not to extend or increase credit to consumers.
Credit scores also determine whether or not you will get the loan, but also your interest rate if the loan is approved. Those with lower scores will most often receive higher interest rates.
How Credit Scores Are Calculated
Most credit scores can range from 300 to 990, depending on the type of score received. In understanding your credit score, you may take steps to improve it. Various credit scoring companies use different factors in determining credit scores, but the idea is usually very similar.
The Fair Isaac Corporation generates a “FICO Score” which is based on a number of determining factors:
Payment History: Your history of paying your credit items counts for 35 percent of your overall credit score. Past due payments, collection accounts, repossessions, liens, judgments and bankruptcies can affect your credit score negatively.
Debts Owed: How much is owed on current debts counts for 30 percent of your FICO score. The company looks at how much you owe, how many accounts you have and compares the amount owed to the amount of available credit. Consumers with higher balances will have lower scores, while those with smaller balances and higher amounts of available credit will have higher credit scores.
Length of Credit History: How long you’ve had credit affects 15 percent of your credit score. For longer lengths of time in which you’ve paid your debts, you will be rewarded with a higher score.
Types of Credit Accounts: Having a mix of different types of credit accounts can positively influence your credit score and accounts for 10 percent of your score. It is best to have installment loans and revolving accounts in order to achieve a higher rating.
Recent Credit Activity: The final 10 percent of your credit score is comprised of any recent credit activity on your credit report. Creditors look at recently opened credit accounts as a sign of potential trouble. However, paying on credit lines that you’ve had over a longer period of time can increase your credit score. Hard inquiries on your credit report can make it appear that you are desperately seeking new credit.
FICO scores range in number from 300 to 850, but with the aid of credit score calculators, consumers are able to improve their scores.
Reasons for Negative Credit Decisions
Equifax notes that there are various factors involved in the denial of credit. These include:
- Serious delinquency of accounts
- Collection efforts initiated or public records filed
- High level of delinquency
- High number of delinquent accounts
- Debt owed is high
- Ratio of balances to credit limits is too high
- Too many accounts that contain a balance
- Length of time in which accounts are established is too short
VantageScore is a credit rating product offered by Experian, Equifax and TransUnion. The credit reporting agencies offer scores between 501 and 990, but the idea behind the score is the same: the higher the score, the lower the risk.
VantageScore uses similar determining factors in its scoring:
- Payment History: Whether or not bills are paid in a timely fashion
- Credit Utilization: How much of your credit limits have been used
- Balances: Balances on accounts that have increased
- Depth of Credit: Length of credit history and types of credit accounts
- Recent Credit: Hard inquiries and recently opened accounts
- Available Credit: Amount of credit available as a whole
While information was previously available with regard to the weights of each determining factor, VantageScore no longer offers this to consumers.
Knowing your credit score provides you with valuable information on whether or not future creditors will extend you new credit. Credit scores are a snapshot of the information contained in your credit history and creditors use this numbered data to assess your ability to repay or default on loans in the future.