Credit scores and how they work

The credit score is a crucial number that helps decide whether or not you are worthy of a loan or mortgage and is a necessary tool used by lenders to decide whether or not to grant a loan to someone. Many consumers are aware that they have something called a credit score, but few appreciate how the system works or how scores are determined.

Many borrowers are at least vaguely aware that a credit report and a credit score is used by lenders to decide whether or not a loan will be granted to them. The most popular credit scoring system is called FICO; the FICO model is named after the company that invented it, Fair, Isaac and Company. Consumers may be well versed with credit reports, but the all-important credit score is less well understood. The FICO credit evaluation system simplifies the essence of a debtor's complete financial history into a three-digit number.

FICO scores are used by lenders, companies, landlords, insurance corporations and any additional place of business that needs to access a "snapshot" of an individual's financial ranking. Credit agencies maintain records of the financial dealings of millions of consumers and offer that information to lenders or creditors when requested as a credit report. All three major credit organizations, Equifax, Trans Union, and Experian that use the FICO score determine the value for it separately, using their own records. Credit reports come with the FICO score, a number varying from 300 to eight hundred fifty. The U.S. average score is 723; higher scores are better.

The FICO score is fundamental, but few people appreciate how it works.

35% of the score is derived by assessing current financial obligations and the ratio of debt to available credit. A borrower can be harmed by having many credit cards or too large a balance on the credit card accounts they have. If your credit cards are at their limit, this portion of the score will reflect it.

thirty five percent of the score signifies the bill paying record of the consumer in question. The payment history portion of the score is determined from information regarding prior borrowing and whether or not they were paid on time or paid in full. Any late payments on auto loans or mortgages are incorporated into this part of the score.

30% is derived by the duration of financial history, the kinds of loans and charge cards the debtor has had, and the number of recent loan applications the consumer has made. As for the types of credit, lenders or creditors seek a variety of types - credit cards, car loans or maybe an equity loan would be preferable to a history that consisted only of charge cards. A longer history is preferable, as it helps lenders make a more accurate assessment of a person's ability to repay a loan. A large number of recent requests for loans might suggest a "desperation" for money, which will affect the report in a damaging way.

Obviously, a long track record of accountable, timely payment of a variety of financial obligations is the ticket to a top notch financial report. By seeing how FICO figures are established, borrowers can more clearly analyze their own situations and pay attention to ensure that their record stays healthy.