Your Credit Score

If your credit report is your “real world” report card, your credit score is your GPA. All of the information on your credit report is sifted down to this three-digit number. It's a very complicated formula that was originated by a company called Fair Isaac, so your credit score is also called your FICO score.

Your credit score can be anywhere from 300 to 850 — the higher the number, the better your score. It's very hard to get an 850, but once you do, your life will be so much easier.

People with high credit scores know how to manage their money, only borrow when necessary, and pay off their loans on time or early. The main benefit to having a high score is that you will usually get a lower interest rate on the loans you need. When lenders see a high credit score, they are so confident you will pay back the loan that they sometimes will give you a 0% interest rate.

Conversely, the lower your score, the harder your finances will be. Bad credit usually results in a downward spiral of life. People with bad credit aren’t usually evil or malicious, just uninformed and often unlucky. The lower your credit score, the less likely you are to get the loan you need at a rate you can afford —or the job you might otherwise be qualified for if it wasn’t for bad credit. If your credit is closer to 300 than 850, your options in life are limited. Most traditional financial institutions will not be able to give you an affordable loan, and if you get strapped for cash, you might have to turn to a payday or title loan company and pay abusive interest rates.

How is my credit score calculated and how do I get it into shape?
Even though no one really knows how a certain account or action will exactly affect your credit score, we do have a pretty good idea of what your score is made of. It consists of five differently weighted categories:

Payment History
35% of your score is based on if you pay your bills on time. So if you don't learn anything else from this Web site, please, PLEASE, PLEEAASE pay your bills on time!

Amounts owed
30% of your score is based on how much money you owe. This is based on the credit limits on cards and original loan amounts on installment loans vs. how much you still owe. This means that you should keep your balances on your credit cards low and pay off your loans as soon as possible.

Length of Credit History
15% of your credit score is based on how long you have been a credit user. This consists of the age of your oldest account, the age of your newest account, and the average age of all of your accounts. To fortify this area, if you get a credit card, keep it open for a long time, and be sure to pay it every month on time (and in full if possible). This does two things for your credit: it builds a credit history, and it builds a relationship with a creditor. If for some reason you might be late on a payment one month, a credit card company is much more likely to be understanding and helpful if you have paid your bills on time every month for the last 5 years vs. you just opened the account two months ago and this is only the second payment that's due.

This section is how students get stuck with high rates as well. Due to the fact that most students do not have a credit history, their score is automatically lowered because they score zero points in this category. Lenders don't know how you will use credit so you automatically become higher risk.

New Credit
10% of your score depends on whether you are taking on new debt. This is where the inquiry section of your credit report comes into play. FICO will look at how many inquiries you have had and adjust your score accordingly. If you are responding to every credit card offer that comes in the mail, that will definitely lower your score. However, FICO is also able to determine if you are trying to open new accounts or just trying to find the best deal. For instance, if you are shopping for a car and you get your credit checked at each dealership you visit and test drive a car, it will temporarily lower your score. These inquiries will later be filtered down because the system recognizes that you were car shopping and not trying to purchase 15 cars. In order to avoid the hassle of having a lower score, even temporarily, get pre-approved for your car loan at your financial institution before you go shopping. This way you will know exactly the rate you will pay and how much your monthly payments will be.

Types of Credit in Use
10% of your score is based on the mix of credit you do have. This has the least impact on your actual score, but it is used if FICO doesn’t have a lot of other information to go on (such as credit history and payment history). This will look at what kinds of accounts you currently have. Do you have experience with installment loans (auto loan) and revolving credit (credit cards)? Try not to get too much of one kind of credit. If you and a friend both owe $10,000.00, but yours is all on credit cards while his is a mix of credit cards, an auto loan, and student loans, you will have a lower score even though you have the same amount of debt.