Credit scores are more important than ever. It is not uncommon for a company to check your credit before extending a job offer, nor is it uncommon for your insurance company to run a routine check every few months. A good credit score can help you land that new job, get a good insurance quote and help get you a lower interest rate on a loan. On the other hand, a bad credit score can do just the opposite and wind up costing you several thousand dollars in higher quotes and interest rates.
Despite knowing how important a credit score is, many people are still confused as to what is actually considered a good score and how it is calculated. Your credit score actually comes from an algorithm or mathematical formula based on information in your credit report compared to information on millions of other consumers. The number is then considered to be an indicator of just how likely you will be to pay back your debt.
A typical credit scale will run between 300 and 850, with the higher the number, the better. Most consumers will have a credit score somewhere between 600 and 800. In fact, only 2% of Americans have a score below 499, 5% have a credit score between 500 and 549, 8% fall between 550 and 559, 12% of the population is between 600 and 649, 15% has a credit score between 650 and 699, 18% are in between 700 and 749, 27% have a rating from 750 to 799 and 13% have a credit score above 800. Typically, any credit score above a 720 will get a consumer the best rates on a mortgage and other loans.
Until recently, most Americans didn’t even know their credit score. This is because the number was a closely guarded secret and lenders were actually forbidden from telling consumers what their score was. This was because many thought that the common consumer wouldn’t understand where the number came from because the formulas were too complex and if people knew their score they may change their behavior in order to change their score making the whole model useless. However, all of this changed when one company began giving out individual’s credit scores. Although, pressure caused the company to stop giving out the information at no cost, public outcry led to new legislation allowing each American a free copy of their credit report each year.
There are several factors that go into your overall credit score. Making up 35% of your score is how you pay your bills. The most emphasis is placed on your recent history or repayment. Paying your bills on time is the best followed by paying the late, having accounts sent to a collection agency and then filing for bankruptcy.
The total amount owed plus the amount of credit you have left will make up 30% of your overall credit score. This is money owed not only on credit cards, but also on your mortgage, home equity lines, car loans and student loan debt. Companies also want to know how much credit you have available as the thinking goes the more you have, the more you will tend to use it.
Your length of credit history will make up an additional 15% of your score. The longer you have had a history of credit, especially with the same companies, the higher this portion of your score will be.
A mix of credit makes up 10%. This means having revolving credit such as credit cards and installment credit like a mortgage and car loans. The more variety the better your score will be.
Credit card applications will make up the final 10%. This model compensates for those who are searching for a car loan or mortgage and can really only be damaged if you have prior credit issues.
There are also several factors that will not affect your credit such as your age, race, sex, length of employment at your current job, marital status, education, whether you own or rent and length of time at your current address.
Credit scores, however, are not perfect and that is why it is important to pull your credit report and make sure that there are no errors which may affect your ability to buy a house or a car.