Credit Score (definition)

Credit Score

Your credit score is a statistical assessment of your creditworthiness, in other words, your probable ability to repay a loan or debt. Some factors taken into consideration are payment history, amount of outstanding debt, income, types of debt, negative information on file, etc. The credit score is usually a number between 300 and 900, and attempts to predict the amount of risk a lender is taking if they grant credit to the borrower. Higher scores are better, and mean the borrower is a more favorable risk and will be more likely to make consistent on-time payments.

Your credit score doesn't just affect whether or not you receive a loan, it can also affect your interest rate, your credit limit, as well as things like car insurance premiums.

Think of your credit score like you would a grade in school, and a higher score, just like a higher grade, is better. Your final grade in school is determined by multiple factors, including quizzes, homework, final exams, attendance, your rapport with the instructor, and more, but probably weighted more by the final exam, and then perhaps graded on a curve relative to the other students.

There are several credit scoring methods, but the one most commonly used is FICO (Fair Isaac and Company, an independent company that came up with the method and computer software used to calculate the score).

Your credit score is weighted by many factors, including the following variables:

your payment history - late payments, especially recent late payments, are a cause of concern. If you've had some late payments years ago, but nothing recently, your score will not suffer nearly as much. Bankruptcies are included in this part of the score. Also, if you've ever been reported to a collection agency, that's also a big negative. About a third of the score is based on this factor.
outstanding debt - how much do you owe? How many credit cards do you have? How close are they to maxed out? About a third of the credit score is based on this factor.
length of time you've had credit - longer is better, because it will cause your payment history to be more accurate and predictable. If you've had a credit card for many years, and don't use it, keep it. It will improve this factor. Of course, if they're charging you an annual fee, you might want to try to negotiate with them about that.
number of inquiries in the past year - when you apply for credit, a notation is made in your report, and a lot of recent inquiries means you've been applying for a lot of credit. The fewer, the better. This factor accounts for around 10% of your score.
type of credit - unsecured loans, credit cards, mortgages, auto loans, the mix of them is taken into consideration. For example, if you were a lender and the borrower owed $200,000 on his house mortgage, you wouldn't shy away from him, but if he owed $50,000 on credit cards, you just might. So if the bulk of your debt is for secured loans, like auto loans or home mortgages, that's considered more favorable than if the bulk of your debt is unsecured loans, like credit card debt.

Now that you know how your credit score is arrived at, you have some idea about how to influence it. You might not be able to improve your score overnight, but if you make an effort to pay your bills early, so that delayed mail doesn't cause a problem with late payments, if you pay for purchases by cash or check more frequently, if you try to keep from maxing out your cards, if you don't apply for more and more credit cards just for the heck of it (or to get the free caps or tote bags with your team's logo), and if you check your credit report occasionally to make sure there is no incorrect information, you can certainly improve your score.

One idea that is debatable is the amount of credit you have available to you. Some advisors think that if you have cards you aren't using, you should cancel them. Other advisors believe that the credit score is more influenced by the percentage of credit that you are using. For example, if you have $30,000 credit available and are using $30,000 of it, you're totally maxed out and that's a negative. On the other hand, if you have $75,000 available and are using $30,000 of it, some feel that is more positive, and some feel that the fact that you can quickly get access to money that you may not be able to afford is a negative. The jury is out on this factor.

If you're interested, you can obtain your credit score by asking for it after applying for a loan, or from several web sites on the Internet., including at the Fair Isaac site itself.