Components of your FICO credit score

There are five key elements that comprise your FICO score: payment history: outstanding debts, credit history age, inquiries, and account types.  Each of these items is given a different weight in the algorithm that determines your FICO score.  Payment history is 35% of the score, outstanding debt is 30%, credit history age is 15%, and both inquiries and account types are 10% of your total FICO score.

Now you know what components are included in your credit score.  What does each of these include?  More importantly, what’s considered good and what’s bad for each component?

Payment History

Your payment history includes the details of how you’ve been paying your bills.  That is, if you’ve been paying them at all.  Each of your credit accounts reports your payments as on time or late.  Late payments are reported as being 30-, 60-, 90-, and 120-days late.  After six months of non-payment, many creditors charge-off your account, deeming it as an uncollectible account.  The more recent the late payments are, the worse the effect it is on your credit score.  Timely monthly payments boost your score in this area.

Outstanding Debts

This portion of your FICO score takes into account the total amount you owe on all your credit accounts.  This includes credit cards, student loans, auto loans, mortgages, lines of credit, etc.  Not only does the FICO score consider the total amount you owe, it also considers the total credit you have available.  This ratio is known as your credit utilization.  The higher your credit utilization – meaning the closer your balances are to the limit – the lower your credit score.  You should keep credit account balances at or below 30% of the limit.

Credit History Age

The length of time that you have had credit is a determining factor of your FICO score.  A longer credit history is better than a shorter one.  This is because there is more data to create a pattern of good or bad payments.

Inquiries

Each time a business uses your FICO score to make a credit-based decision about you, an inquiry is made to a credit bureau.  This inquiry then appears on your credit report.  Multiple inquiries within a relatively short period of time have a negative effect on your FICO score, especially if these are credit card inquiries.  Few to no inquiries is better.  The good news is that only inquiries from the past two years are factored into your FICO score.

Account Types

When you have several different types of credit accounts – loans and revolving credit – it is better than having a single type of credit account.

Your FICO score

One very important element in your overall credit worthiness package is your FICO score. But what exactly is that and how does it affect your debt management choices?

FICO is an acronym formed from the letters of its founder, the Fair Isaac Corporation. It is a number between 400 and 800 that ranks credit worthiness according to a proprietary algorithm invented by the company, with 400 being worst and 800 being best. Other companies now have their own variations.

Though the details of the algorithms are closely held trade secrets, over the decades many people have reverse engineered several of the important factors. Any late payments will lower your score, and the more of them and the later they are, the more heavily the score is affected. The total amount of debt carried per month is another element. A less important factor is the number of credit cards and credit checks performed.

Any score below about 620 is considered marginal and below 580 is decidedly poor. 720 and above is very good to excellent. A range between 620 and 720 represents a kind of gray area, where items other than your FICO will play a more significant role in loan decisions.

Banks, mortgage companies, credit card issuers and other lenders will use your FICO score as a very important criteria for deciding whether to make a loan, and at what interest rate. Other things being equal, the higher your score, the better interest rate you can obtain.

Of course, many times all other things are not equal. Prevailing interest rates in general, the current demand for loans, the general economy and other factors have a heavy influence on the willingness of lenders to lend and at what rate.

How the current economy and credit crunch will affect you

The entire lending industry has undergone at least two significant shifts in the last 20 years. With the increasing use of computers and modern financial techniques, underwriting loans is done very differently today. Also, not surprisingly, the Internet has shifted finance to a very different mode of working. However, most significant has been the fallout from subprime loans, the housing bubble burst and the resultant economic domino effect this has had. Without an excellent FICO score and solid employment history, it will be very difficult to obtain credit for at least the next decade. Those with marginal credit will find current credit card limits reduced and interest rates raised.

Because of these changes, the FICO score remains a primary tool for lenders. It may not determine the final decision, but it definitely influences the ‘first cut’ when presented with a stack of applications to approve or disapprove.

Fortunately for those who have slipped up financially, there are alternatives. Though your FICO may be low, you may have several options. The first thing to do is set into motion a plan to improve your score. Even though you may be unable to obtain credit - even though you may not want to obtain credit immediately - your FICO score is a work in progress and when you go to obtain credit, you want it to be as high as possible. There’s no better time than now for working on improving your credit rating and reducing your debt-to-income ratio.

As you work to remove those outstanding overdue debts - either through paying them off or negotiating with the lender - your FICO will gradually improve. The age of 30 day past due, 60 day past due (or longer) late payments is a factor in calculating your FICO.

At the same time, you can shop around for lenders willing to take a higher risk by lending you money. The downside is those loans almost always carry a higher interest rate. Your best approach is to try to forego borrowing for as long as possible while you work to improve your debt situation. Your FICO will follow suit.

Credit Reports and What They Mean To You

Credit reports are often regarded with dread, especially by those who have entered turbulent financial waters. But reality is never your enemy, even when it is unpleasant. In order to promote financial health, and resolve any debt problems you may have, it’s essential to have the best information possible about your credit status. That information is found - both by the lender and, more importantly, by you - in your credit reports.

Those reports are maintained - at least in the U.S. - chiefly by the three major credit reporting agencies:

• Equifax - Get Your Equifax Credit Report Now!
• Experian
• TransUnion

The reports contain a multi-year history of your credit cards, home loans and other debt. They also record any late payments that occurred and how late they were, 30-day past due, 60-day past due, etc. The reports will list any current and old address, and often your phone number and social security number.

That information is readily available to any qualified party - a bank, a mortgage lender, a credit card issuing company and certain others during legal proceedings. But, though the companies all genuinely try to maintain accurate records, the reports may contain errors. It is important to check your credit report and make sure it’s accurate.

They may list loans as active that have been paid off. They may list current credit cards you canceled long ago. And, they may fail to list payments made to make up overdue amounts. Often, this isn’t sloppiness on the part of the credit bureaus but simply a reflection of timing and other common human errors in keeping records. The world may be computerized, but those databases still don’t always communicate effectively between companies using different systems.

The only thing an individual can do about this - out of self-protection, if nothing else - is to get copies from all three agencies and review them thoroughly. Make a note of any errors, establish proof of the error, then send a registered letter with the proof to the agency asking them to correct the data.

Remember that your credit score is affected by the number of inquiries. If you are planning on financing (or refinancing) a loan, getting a line of credit or auto loan and you want to know where you stand, it’s best to plan ahead. Order your credit report 6 months in advance, if possible.

You can order your credit report free of charge, one time a year, from any of the above companies. However, there are services that will not only provide you with a free report, but will help you interpret the report and score. Try some of the following companies:

• Get your FREE credit score and more!
• Go Free Credit: Do you know all the facts about credit scores? Click Here!

Remember these free services provide you with the same information as Experian, Equifax and TransUnion. There is no need to order a report from all three agencies or from a free service AND the agencies.

On a more positive note, having the information at your fingertips allows you to develop a debt-free plan for your future. Understanding your past credit history is the first step in creating that plan.

Review your history and note any current overdue amounts. Clear those up first, as quickly as possible. One method is to pay off any smaller outstanding amounts first. That frees up funds to be used on the next larger outstanding amount. Working your way up, you will eventually begin to see light at the end of the tunnel.

We will be covering ways to clear errors in the report, what it takes to raise your credit score and how to manage your money and stay out of debt. Please subscribe for updates.