Credit Score Basics

Everywhere you turn, you hear and read about FICO credit scores. Are they really that important if you’re not in the market for a loan or credit card? Yes.

There are four major reasons why you need a good credit score. It determines:

  • Whether you’ll be approved for credit for mortgages, car loans, installment loans and credit cards
  • What interest rate you’ll pay on those loans
  • The cost of your homeowner’s and car insurances
  • And in some cases, whether you get that job offer you’ve been hoping for

Ultimately, a poor score costs you more.

How FICO Scores are Calculated

The best way to ensure a good FICO credit score is to manage your credit responsibly over time. To maximize your score, it’s important to understand what goes into the calculation and how much each factor is weighted:

Types of Credit in Use: 10%

Considers the number of credit accounts and the mix of credit types: credit cards, installment loans, mortgages, etc. This is most important if you don’t have a very long credit history.

Payment History: 35%

Takes into account:

  • Many different types of payments, including mortgages, major credit cards, department store credit cards, car loans and other installment loans such as furniture, etc.
  • Information from public records, such as bankruptcies, liens, lawsuits, foreclosures, judgments and wage garnishments.
  • Details of any missed or late payments such as the amount, how long ago it occurred and how late it was.

Amounts Owed: 30%

Looks at:

  • The total of all the amounts you owe for all accounts
  • The mix of amounts owed (credit cards vs. installment loans, for example)
  • The number of accounts that have balances
  • How much of your total credit is available on credit cards and installment loans (the closer you are to maxing out your available credit, the more negative the impact on your score)
  • How much of the original balance borrowed you still owe on installment loans, such as a car loan.

Length of Credit History: 15%

As long as you don’t have negative information in your file, the longer your credit history, the higher your score.

New Credit: 10%

Considers:

  • How many new credit accounts you’ve opened recently
  • How long it’s been since you opened a new credit account
  • How many requests you’ve made for credit recently
  • How long it’s been since lenders have requested credit information on you
  • How good your recent credit history has been.

Improving Your FICO Credit Score

Armed with information about what goes into the calculation of your credit score, you can develop your own plan for improving your score. Here are a few of the ways you can improve it:

  • Order a copy of your credit report. Review it carefully and correct any significant errors.
  • Pay your bills on time. Try to pay a week early, if possible.
  • Don’t open many new accounts over a short time period, especially if you have a short credit history.
  • Shop for credit over a short period of time. FICO scores distinguish between searching for credit for a specific loan and searching for many different credit lines.
  • If you have a questionable credit history, open a few new accounts, use them responsibly and pay them off on time.
  • Don’t open credit accounts you don’t intend to use, such as opening a retail account for a one-time discount. A new account lowers your average account age, which could lower your score by up to 10 points.
  • A credit card or installment loan can improve your score as long as you don’t have too high a balance and you pay it off in a timely manner.
  • Keep your balance low in relation to your available credit. If your credit limit is $10,000, keeping your balance below $2,500 (25%) will improve your score. Maxing out your credit cards could lower your score by as much as 70 points.
  • Pay off credit card debt rather than move it around to lower rate cards. Moving balances to other credit cards and closing out the old balance can hurt your score because it can change the ratio of your total credit card balances to your total available credit lines.

How Long Will It Take To Improve Your Score?

Negative items affect your credit score much more quickly than positive items. Late payments can negatively affect your score in just a few months, whereas paying bills on time may take six to twelve months to generate a significant improvement in your score. So always pay your bills a little early. Charge-offs, judgments, bankruptcies and other public records can remain on your report for seven years.

There are three major credit bureaus: ExperianOpens in New Window, EquifaxOpens in New Window and TransUnionOpens in New Window. The credit bureaus write up your report based on any information they receive about you from companies that gave you credit in the past. This can include your payment history, the length of your credit history, the types of credit you have and amounts owed. You should review your reports from all three credit bureaus for accuracy once a year or at least a few months before applying for credit. If you are denied credit, you’re entitled to a free credit report from the bureau supplying the information that was the basis for denial.

From that report, a credit score is derived – which ranges from 300 to a perfect 850. Ideally, you want to maintain your score above 620 as that is often a drawing line for creditors. The median credit score in the United States is around 723.

*APR=Annual Percentage Rate. Rates are subject to change at any time. SVFCU will determine your rate based on credit history, income, debts and related factors. **LTV=Loan to Value. ***Rate is subject to change quarterly. Rate is equal to the Prime Rate plus a margin and a ceiling of 18%. Interest paid on home equity loans is generally tax deductible, regardless of the use of the funds. Your tax situation may vary; for specific tax information, please consult your tax adviser.