Explain Credit Score

Resources to explain credit scores help make sense out of an otherwise meaningless number. These numbers are not arbitrarily determined; they result from a complex but logical equation. The software used to explain credit score data was developed by Fair Isaac Corporation (FICO), so the number is often referred to as FICO. These figures are used by potential lenders as a numerical representation of their estimated risk should they lend a consumer money. The higher the figure, the lower the lender's risk. Consumers with higher numbers are considered more likely to repay their debts on time. Those with lower numbers will suffer higher interest rates or not be able to obtain loans at all. "The rich ruleth over the poor, and the borrower [is] servant to the lender," (Proverbs 22:7).

The best way to explain credit scores is to start with how they are calculated. Based on an individual's social security number, his or her financial history data is plugged into software by one of the three major reporting agencies. The software analyzes various aspects of the information and comes up with the FICO number. Each reporting agency might use the scoring software differently, so don't expect the same number from each.

Although each of the three reporting agencies explain credit scores slightly differently, they all use roughly the same formula. The most significant factor is the payment history; that is, whether the bills are paid on time and whether there are any delinquent accounts. These factors account for about 35% of the final number. The next most significant factor is the current debt load, meaning how much is owed on all of the open accounts. This helps to evaluate whether the person is currently overextended. This accounts for about 30% of the final number.

Another factor used to explain credit score calculations is the length of an individual's financial history. This is the total length of time that all accounts have been tracked by the reporting agencies, and it accounts for 15% of the final number. The longer the length of good payment history, the higher the number. Finally, reporting agencies look at types of loans and the number of new accounts that have been opened. Each of these factors accounts for 10% of the score. Knowing these factors can help explain

Regarding types of accounts, agencies reward higher numbers to those who have a mixture of account types (installment, mortgage, revolving) than those with numerous accounts of the same type (revolving charge cards, for example). Reporting agencies also look at how many new accounts have been opened recently in comparison to the total number of accounts. A significant number of new inquiries or an unusually high number of new accounts can lower one's FICO.

The aforementioned factors are used by software to generate a number, but to clearly explain credit score, you must also understand the scale. Most scores range from 340 to 850. The higher the score, the better. An excellent score is typically viewed as 700 or above. Borrowers with FICO numbers in this range will be offered the best financing options and mortgage rates. About 30% of Americans have scores from 600-699. Plenty of financial institutions are willing to work with people with some blemishes in their financial histories. However, people with numbers under 500 will pay more in interest rates and fees if they are approved for credit. Banks and other lending institutions typically use the middle score from the three supplied by the reporting agencies to evaluate and process loan applications.

The best way for anyone to fully understand and explain credit score implications is to find out their own FICO score. Request a free copy of your credit report from any of the three major agencies and read them thoroughly. Report any inaccuracies to the agency immediately so that they can investigate the account and make the necessary changes. In addition to lending rates, your score can affect your search for employment. Make use of resources to explain credit scores and take charge of your finances so that you might give yourself every advantage.

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