Television programming is often saturated with advertisements for credit reporting providers. When combined with the increased incidence of identity theft, consumers are more aware of their credit scores than ever before. That said, many people do not fully understand how these scores are derived, or more importantly, how they can improve theirs.
Credit agencies gather a great deal of information on the spending and saving habits of consumers. Depending on a number of factors, such as income, debt ratio, assets and payment history, a consumer might seem like either a sensible investment or a severe risk to a lender. For those reasons, credit bureaus often condense the vast information into a mathematical metric, which is the credit score. This allows lenders and merchants to run a credit score check and use that information to make quick, effective decisions regarding the credit history and worthiness of a customer. There are a number of credit score agencies, including FICO, Experian, Equifax and Transunion. The most widely used score in the United States is the FICO score.
Why Do You Need It?
Credit scores are used by lenders to make lending decisions. That means when a person applied for a credit card, a mortgage or an auto loan, their applications would be either approved or rejected after the lender ran a credit score check. Of course, other factors came into play, but credit score is a major component of the decision. The applicant’s credit score could also impact other factors, such as interest rate and the availability of incentives.
How it is Built
A person’s credit score is built through a combination of historical factors related their payment history and financial status. The majority of the score is derived from the applicant’s payment history and their use of credit (the credit history). On time payments and responsible credit use allows for a higher score. Other smaller factors include length of credit history, types of credit used and recent searches for credit. These all combine to form a numerical score, ranging from 300 to 850.
What Can Impact it Negatively
People who have a low income to debt ratio or a history of late and missed payments will obviously have a lower credit score than those who do not. However, there are other less obvious detriments to a person’s rating. For example, a person who has never utilized credit will have a lower score, even if they pay all of their bills on time or have a significant savings.
Another often-overlooked factor is the number of times that your credit score was checked recently. Many times, when applying for a line of credit, people submit multiple inquiries in an attempt to get the best rate. While there are safeguards in place, this can have a short term negative impact on your credit score, due to the appearance of attempting to open multiple lines of credit.
Today, credit score is used for a number of other purposes as well. As such, it must be consistently monitored and legislation must be passed to ensure accurate and responsible reporting of these scores. These auxiliary uses of a person’s credit score include applying for insurance, entering into a lease agreement for housing and even applying for a job. These uses are often criticized however, this has not stopped the practice from taking place. You can view your annual credit score for free at www.annualcreditreport.com, but you will have to pay a small fee to see your FICO score.