Three Magic Numbers

Your credit score is arguably one of the most important numbers that you carry. The three digit score can help you buy a house, rent a house, buy a car and even get a job. Having a good score will help you get a lower interest rate, while a lower score can keep you from getting a loan. I feel like so many of us know so little about our credit scores – it is just a magic number that we know nothing about.credit score

Who came up with the credit score?

Banks needed a way to determine whether a candidate for a loan would be a good borrower or a bad one. No one wants to lend money to someone who is likely to default on their loan. In the 1980s, the Fair Isaac Corporation came up with a credit score based on a number of factors. This quickly grew in popularity, and hence your “FICO” credit score is now the industry standard. The three major credit bureaus that track and compute your scores are Experian, Equifax and TransUnion.

How is your score calculated?

The actual method to compute your score is proprietary but the following is an approximation of how your score is computed:

  • 35% payment history. Make your payments on time and your score will go up. Miss a payment or consistently pay late and your score will decrease.
  • 30% outstanding debt. How much of a balance are your carrying on your credit card? While some credit card debt is normal, the lower the amount the better. Keep an eye on your credit card debt and try your best to keep it low.
  • 15% length of history. How long have you had your credit card? Paying your bill on time and keeping your balance low for a longer time will look better than someone who has just opened up their first card.
  • 10% inquiries and new accounts. Hard inquiries are initiated when a lender runs your credit score. Your credit score will slightly decrease when your score is checked. The logic here is that someone who is having their credit checked frequently probably is shopping around to find a lender that will lend them the money – i.e., probably not the ideal candidate. On the other hand, a soft inquiry is when you check your own credit score and you are always welcome to do that. Opening up new accounts will temporarily cause your score to take a dip  but it should increase with good credit history.
  • 10% types of credit. Someone who has demonstrated good credit history throughout buying a house or car as well as by using credit cards will have a lot more good history to prove that they are creditworthy. Having just a credit card is good, but having more types of credit is a plus.

What is a utilization ratio?

One quick method that lenders will use to compute your score is the utilization ratio. Take your total outstanding debt and divide it by your total available credit. Someone who carries a $700 balance and only has $1,000 in credit would have a ratio of 70%. However, someone who carries a $700 balance but has $2,000 in available credit would have a score of 35%, so they are viewed as less risky. It is important to note here that having a higher credit limit is viewed as a good thing.

Where can I check my score?

There are various websites out there to check your credit score. A lot of banks will also offer this service (might be a bit more reputable and a bit cheaper). You can normally get your score for free, so keep that in mind if you’re pressured into paying for it. As mistakes can (and do) happen, keep an eye on your credit score. Be on the lookout for potential fraud or errors that the credit companies will have made recording your credit history.

How will having good credit help me?

In addition to actually being taken seriously for a loan, this will also help you get a lower interest rate, which is always a good thing, as you’ll pay less in interest. Your credit score is run for a lot more than just getting a loan. When I got my current job, moved into my apartment and opened utilities, they ran my credit. Do yourself a favor and maintain a good credit score.

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