What is Credit?
Your credit score reflects your creditworthiness at a given point in time. Used by mortgage lenders, car loan lenders, credit card companies, landlords, cell-phone companies, and even potential employers - your score is the key to your financial life. Scores range between 300 (very bad) and 850 (very good). There are three main bureaus that provide credit scores and reports to businesses and consumers.
- Trans Union
Each provide a detailed report on credit usage and credit score. Most institutions will only pull from one bureau, while mortgage providers will pull from all three to get the most accurate assessment of a person’s credit. Your credit score will not be exactly the same when pulled from each different bureau, but they will fall in a narrow range that determines your borrowing risk. Yes, institutions use your score to evaluate how risky it is for them to lend you money. Your score overall determines how well you manage your money.
What is a FICO Score?
This credit scoring model was developed by the Fair Isaac Company (FICO), which is used by institutions to determine how credit worthy you are. This score is a complex calculation that takes into account several aspects of someone’s financial history and habits.
Payment History (35%)
This aspect of your financial history carries the most weight in determining your FICO score. It is calculated from previous accounts like credit cards, retail accounts and installment loans. Factors from these accounts include the number of past due payments, the amount of the past due payments and the severity of delinquency. Not making the required payments on time for your everyday loans and credit cards greatly affects a FICO score.
Capacity is the amount of credit you have available. This is weighted heavily because data shows that people who go bankrupt max out their credit cards before filing for bankruptcy. The FICO model considers three components of an individual’s credit:
- Loan balances compared to the original loan amount
- Revolving loan (i.e. credit card) balances compared to their credit limit
- Total revolving balances compared to the total limit amounts
It is best to simply keep low balances on all lines of credit instead of closing or consolidating accounts.
Length of Credit History (15%)
A longer history of credit works favorably toward your FICO score. That is why it is important to begin establishing credit as a young adult. However, you do not want to open several accounts in a short period of time; this will not benefit your score. Credit inquiries are tracked on your credit report for 24 months, but only inquiries from the most recent 12 months are included in the FICO score.
Types of Credit (10%)
Your FICO score takes into account the overall mix of credit types. As odd as it sounds, it is ideal to have a good balance of debt. By having a variety of debt such as revolving credit (credit cards), mortgage debt and installment loans (i.e. auto or personal) it shows that you are a well-rounded borrower. Although, you do not want to open new credit for the purpose of balancing your debt.
New Credit (10%)
This component is based on how many recent new accounts you have opened. Your score is impacted when an institution pulls your credit. However, your score can be pulled several times in a two week period and it will only count as being pulled once in that time frame. The credit bureaus understand that you may be shopping for a new car or looking to take out a mortgage. In instances like this, your credit may be pulled many times in a small time frame in order to finance a large purchase, and that is okay. What you want to avoid is consistently applying for accounts that require a credit pull over a long period of time.
If you are concerned about your credit score or would like to learn more, FFCU offers credit advising. Make an appointment to discuss your credit.