Understanding your credit score can help you take steps to
improve your credit rating or reputation. The main benefit of having a better
credit rating is not about the chances of getting a loan since with bad credit
you can still get a loan. But the better the rating the lower is the interest
charged by lenders.
According to myfico.com, the difference in interest charges between a
person who has a
score of 500 and other with a 720 score is 4.54 percentage points. This
means, on a $ 100,000, 30-year mortgage, you could pay an extra $117,152
in interest charges. Or, in monthly payment, the difference would be
$326. And remember, this potential saving is only for one loan.
What is a Credit Score?
Credit score is a number generated by a formula based on information
on your credit report compared to the credit
performance of others with similar profiles. In this scoring
system, a total number of points predicts how
likely you are paying your bills when they due -- your credit worthiness.
The scoring scale ranges from 300 to 850 and about 85 percent of people
in the U.S. have scores between 600 and 800. There are slightly differences at
the three reporting agencies scores. But since Fair Isaac Corp. developed all
the three scores, if your information were identical at all the three bureaus, your scores from all the three would be
within a few points of each other.
For loan application approval, a credit rating is more objective than
judgmental methods because it's based on real and empirical data of
millions applicants. This objectivity supports the Equal Credit
Opportunity Act (ECOA) that doesn't allow lenders to predict borrowers
risk based on factors, such as race, sex, marital status, national
origin, or religion.
How a Credit Score is Calculated
Your credit rating is actually a grand tally of your credit report
figures. It is the total of various figures divided by the
number of items involved. The numbers
involve can range from 300 to 900 and the formulas are derivations of the
following data:
35% of the score is from your payment history. This data speaks of
how well you handled credit. It has the largest percentage because
lenders are more concerned on how timely and devotedly you pay your
bills.
30% of the score is on your existing debts.
There is a rule to keep credit balances at 25%, so having a handful of
accounts at its seams won’t help your credit score.
15% of the score is how long you have handled credit.
The longer the time you handled credit is the better for your score. If you have
been on credit for a long time lenders
will judge you as an experienced money handler.
10% of the score is the number of inquiries.
Frequent inquiries made to your report would mean a financial
instability on your part. If you are that anxious to see credit reports
that would also mean you are checking how lenders are reacting to your
payments and credit.
10% of the score is the types of credit you currently have.
How a Credit Score Works
The most widely used credit scoring system is FICO score. Lenders use the FICO score to make loan and interest rates decisions. The rate you
received from a lender is directly related to your credit rating. The
higher your number means the lower interest rate you'll be charged.
When a lender receives your score from a credit bureau, up to four score
reasons are given. If the lender rejects your loan application, these
score reasons can help the lender tell you why your score wasn't higher.
These score reasons are more useful than the score itself in helping you
determine whether your credit report might contain errors.
So, understanding your credit rating long before you apply for a loan can
help you take steps to improve
your credit rating and save from a lower interest charge. From the above
calculation you have seen that being careless with your credit can result in ten
thousands of potential loss.
