Credit Score

Credit scores are used by lenders and others as a measure of your creditworthiness.  These scores are based on mathematical algorithms that take information from your credit history into account. You may be surprised to learn that you have more than one credit score.  Although the best-known score is the FICO Score, created by the Fair Isaac Corporation over 25 years ago, a number of other companies have developed their own proprietary models to calculate credit scores.  Experian has a model called Experian PLUS, and TransUnion has TransRisk.  In 2006, the three major credit bureaus, TransUnion, Equifax, and Experian, created VantageScore, the newest version of which is VantageScore 4.0, which utilizes trended credit data.  And you even have more than one FICO Score.  Some lenders, such as mortgage brokers, credit card issuers, and automobile finance companies, prefer to use an industry-specific FICO Score when evaluating the creditworthiness of a potential borrower.  

What Is a Good Credit Score?

The credit scores provided by the newest generation of VantageScore and FICO typically range from 300 to 850. (Industry-specific FICO Scores have an expanded range of 250 to 900.) The higher your number, the better.  However, what is considered a “good” score can vary by lender.  This said, a FICO Score lower than 580 labels you as a high credit-risk borrower, in which case you may not be able to get a loan at all.  Many, but not all, lenders will approve loans for those with a “fair” FICO Score (580 to 669), but you will probably have to pay a higher interest rate.  Generally speaking, scores from 670 to 739 are thought to be good, while scores in the range of 740 to 799 are considered very good, and a score above 799 is exceptional. According to VantageScore, a “prime” score calculated using that model would range from 661 to 780. Currently, the FICO score range is often used as shown below:

  • Excellent: 800 to 850
  • Very Good: 740 to 799
  • Good: 670 to 739
  • Fair: 580 to 669
  • Poor: 300 to 579

Knowing the factors that go into calculating your credit score can aid you in maintaining a good score or improving a bad one. Both FICO Score and VantageScore consider the following five components in their calculations:

  1. payment history
  2. credit usage ratio
  3. credit history length
  4. credit mix
  5. recent credit applications

Your payment history reflects the timeliness of your payments.  Late or missed payments will negatively affect your score, while the greater percentage of on-time payments you have, the higher your score will be.  

The credit usage ratio is the total amount of your outstanding balances as a percentage of your available credit.  This is calculated each month, on both a per card basis and an overall basis. If you carry credit card balances that are at or close to the maximum credit available on your cards, this ratio will be higher and your credit score will be lower.  You can quickly improve your credit score by paying down some of those balances.  

The length of your credit history plays another role.  The longer it is the better since it indicates you have experience in managing your credit obligations.   This is a good reason to hang onto an old credit card that you may no longer use.  Cancelling it and getting a new card negatively affects the length of your credit history, and, ergo, your credit score, all else equal. 

The different types of credit you utilize and recent credit applications also affect your credit score.  The greater the variety of credit sources you utilize (credit card, student loan, car loan, mortgage), the higher your score will be, assuming your payments are timely, because it tells lenders that you have experience handling a number of credit obligations.  On the other hand, if you apply for new credit from a number of sources within a short time period, it will negatively affect your score since this is a red flag that you may be experiencing some financial difficulties.

While both the FICO Score and VantageScore models focus on the same five components, the scores they provide will differ, due in part to the fact that different weights are applied to each.  For example, payment history carries the highest weight (35%) of the five factors in the FICO model, but it is only “moderately influential” in the VantageScore 4.0 model.

Having a good credit score has a lot of advantages. Not only can you often negotiate a lower interest rate and/or other credit terms, but your score is also used by rental agencies and automobile insurance companies.  A high credit score can result in your ability to rent any apartment you wish and may also result in a lower insurance premium.

 

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