Understanding How Credit Scoring Works

Do you know how the credit scoring system works? Many consumers may be familiar with a credit report and credit score, but some may not fully understand the whole process behind the credit scoring system. In this article, let’s talk about basic facts about credit reporting. Understanding how credit scoring works will help you avoid bad debt and keep your personal credit in good standing.

What is a credit score?

The credit score is numerical value used by credit reporting agencies to define an individual’s credit worthiness. Banks, lending companies, and creditors check credit report scores to determine whether a person can be granted approval. Some lenders may require a high credit score while others can be less exacting when it comes to gauging credit scores.

There are three major credit reporting agencies that monitor account activities of consumers. These are Equifax, Experian and TransUnion. Each credit bureau does its own independent reporting and uses its own credit scoring model.

Equifax uses the FICO scoring system, created by the Fair Isaac Corporation. The other two bureaus Experian and Trans Union created their own model which is based on the FICO scoring system. The FICO score ranges from a low of 300 to a high score of 850.

Calculations are made based on five basic factors: payment history (35%), credit utilization (30%), length of credit history (15%), types of credit (10%), and credit inquiries (10%). Based on these criteria, it is easy to see why timely payment of your bills can dramatically affect your personal credit rating. At 35%, even a few misses on your due dates can badly pull down your credit score.

Another significant factor is how you utilize your credit limit. Credit utilization makes up 30% of your total FICO score so if you have a high debt-to-credit ration, your score can really drop. This is why financial experts recommend not using more than 40% of your credit card’s limit, even if a credit card offers zero APR or a low interest rate. If you get into the habit of maxing out your limit, your credit score can suffer.

The other three factors are just as important. Length of credit history makes up 15% which is why students are encouraged to apply for their own student credit card as soon as they are ready to handle debt and repayment.

What about the types of credit you use? This makes up 10% of your FICO score. For instance, owning multiple credit card accounts will not boost your score. You can show your capability to handle debt and credit effectively by managing different types of debts such as a personal loans, mortgage, auto loans, aside from a credit card.

Finally, credit inquiries or hard inquiries made by creditors in response to your credit application can affect your credit score. This is why consumers are strongly advised not to submit multiple applications to various lenders at once just to see who will grant approval more quickly. Instead, you should take time evaluating your options and once you have found the right creditor, then that’s the only time you can submit an application.

 

About the Author:

Suzy Vanstrusen is a credit analyst and a writer on the website EZCreditRepairSolutions.com. She has been providing consumers with tips and wise information about credit repair as well as helping you out more with your bad credit loans.  Copyright © 2011
 

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