How your Credit Score is calculated

Credit scores are used by many different companies to measure the credit worthiness and financial stability of consumers. While there are several different companies that offer scores, the FICO (Fair Isaacson Corporation) is the model that is used most often.

There are five key components that determine the overall score or rating.

1. The most emphasis, 35% of the overall score, is placed on payment history which reflects whether the borrower paid on time and as agreed by the terms of the credit. Being late, missing payments or going into default would have adverse effects on this part of the score.
2. The second largest component, 30%, is credit utilization or the amount owed in relation to amount available. If a person has a $4,000 balance on available credit limit of $20,000, they would have a 20% ratio and would be considered acceptable. Owing $15,000 on $20,000 of available credit would be a 75% ratio and would negatively affect this part of the credit score. FICO says people with the best scores average around 7% credit utilization. Using anything over 30% of your credit limit will adversely affect your score.
3. The length of time each account has been open and the account’s activity determines 15% of the total credit score. By having a longer credit history, the credit provider has a better indication of the borrower’s long-term financial behavior. Having an open account without activity doesn’t offer a provider much information.
4. and 5. New credit and Types of credit each account for 10% of the total score. New credit can adversely affect a score because it is a new obligation without history of how it will affect the borrower’s ability to repay all of their liabilities. Types of credit include both revolving and installment debt. A good mixture of each can indicate less risk for lenders.

The combination of all five areas make up the total score which lenders use to determine credit worthiness. Another confusing issue is that all credit scores are not mortgage credit scores. This particular score determines not only whether the lender will make a mortgage but at what interest rate.

Your credit score affects your car insurance and loan payments, utility deposits, cell phone and your cable deposits and/or payments. The best place to get your credit score if you’re planning on purchasing a home is from a trusted mortgage professional. This person will be able to suggest things to improve your score if necessary.You can also get a free copy of your credit report each year through www.annualcreditreport.com from the three credit-reporting agencies Experian, Equifax and Transunion. It is a good idea to do this at least once per year to check that your creditors are reporting correctly and there is no incorrect information being reported.