Understanding Your Credit Score
Posted 9 October 2007, 14:00 in Personal Finance Leave a Comment
Imagine if we lived in a cash based society, where there were no such thing as credit cards or bank loans. Would you have enough money in the bank to purchase a house? a car? or huge flat screen that you have always wanted? For most of us, we do not have the available funds to purchase these items outright. The good news is that banks are willing to lend anyone money as long as they have a good credit score.
Your credit score may affect you by the following:
- Interest rate that you receive on a loan
- Insurance rate on your auto or homeowners insurance
- Ability to obtain credit
- Ability to obtain employment
Your credit score is broken down by the following:
- 35% Payment History
- 30% Amount of Debt Owed / Debt to Credit Ratio
- 15% Length of History
- 10% New Credit Inquiries
- 10% Credit Types
Payment History 
Lenders want to know if you are paying your bills on time, which is why a huge chunk of your score is weighted based on your payment history. It is recommended to check your credit report and be sure it is clear from any discrepancies, since negative marks will adversely affect your score.
Amount of Debt Owed 
Lenders want to know if you are responsible when money is given to you. If a bank lends you $10,000, will you “max” it or just use a portion of it? A good debt to credit ratio is under 10%. This means that if a credit card company lends you $10k in credit line, you will use less than $1k.
Length of History 
15% of your credit score is based on the length of your credit history. The longer your credit history, the better. Students right out of high school (typically age 18) will not have any credit history. To establish credit, the easiest route for anyone would be to obtain a credit card. Since the length of your credit history is based on active accounts (accounts that have not been closed), you should find a credit card with favorable terms that is at a bank or credit union that you respect and keep the credit card active forever. According to David Bach, author of Automatic Millionaire, “[i]f you close your old accounts, you’re shutting down your credit history.”
New Credit Inquiries 
10% of your credit score is based on whether or not you are shopping for credit. This is known as a hard credit check because it is recored on your credit reports. You should apply for credit only when necessary because every new application will result in a hard check.
Type of Credit 
The last 10% of your score is based on the mixture of your credit accounts. Credit types include installment loans (i.e., student loans, mortgage, auto loan, etc.) and revolving credit (i.e., credit cards). The formula on which combination of credit works best is not published, but one could guess that installment loans are better than revolving credit.
The best place to find your credit score is through MyFico.com, since many lenders use the FICO score as the basis of their decision making.
Related Articles: How to Opt-Out from Receiving Credit Card Offers
Related Links: Credit Education | Nine Steps to a Great Credit Score | Get Ready for Two Credit Scores | How Bad Credit Can Impact Your Life
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