Credit Scoring

Learn what a credit score is and how to improve it.

You may not even know that you have a credit score, but you do -- and it's used by credit card companies, home equity lenders, auto loan lenders and finance companies when you apply for credit or a loan. Produced with a computer model created, most often, by Fair, Isaac & Co. (or "FICO," leading to the somewhat generic term "FICO score"), a credit score is intended to be a snapshot, or summary, of your credit history. A low score can mean you don't get a credit card or loan, or that if you do, you will pay a higher interest rate. Also, some lenders use your credit score and other information to set the "price" for your loan.

Factors Affecting Your Credit Score

While we don't know exactly how a credit score is determined, FICO considers the following factors (the approximate weight it assigns to each factor is in parentheses):

• Payment history (35%). Your score is negatively affected if you have paid bills late, had an account sent to collection or declared bankruptcy. The more recent the problem, the lower your score -- a 30-day late payment today hurts more than a bankruptcy five years ago.
• Outstanding debt (30%). If the amount you owe is close to your credit limit, that is likely to have a negative effect on your score. A low balance on two cards is better than a high balance on one.
• Length of your credit history (15%). The longer your accounts have been open, the better.
• Recent inquiries on your report (10%). If you have recently applied for many new accounts, that may negatively affect your score. Promotional inquiries don't count.
• Types of credit in use (10%). Loans from finance companies generally lower your credit score. FICO says this is most important when there isn't a lot of other information upon which to base a score.

Although this is a good guide as to what credit scoring companies deem important, keep in mind that some companies may consider different factors.

What the Numbers Mean

Credit scores range from 300 to 900, with the average around 750. According to the model, as your score increases, your risk of default decreases. Industry experience shows a direct correlation between low scores and high default rates. This means that you may have a hard time convincing a creditor to make you an affordable loan (or any loan at all) if your score is far below average. But just as your credit history can vary from credit bureau to credit bureau, so can your credit scores. It is possible to have a high score with one credit bureau (Equifax, Experian or TransUnion) and a low credit score with another, just as you might have a clean credit history with one bureau and a muddied record with another.

Wide-ranging credit scores are rare, however, although some lenders admit to seeing borrowers with scores that vary by 100 points or more. To combat this, a lender usually uses the middle score -- but that can be of little comfort if you have scores of 550, 570 and 700, and the interest rate for a borrower with a score of 570 is two points higher than the rate for a borrower who scores 700. Narrow ranges are more typical. For example, a person with good credit might have scores something like 685, 702 and 710.

How to Get Your Credit Score

Credit scorers are not required by law to reveal credit scores to consumers. And for years, they haven't. But happily, that is changing. Recently, Fair Isaac, in partnership with Equifax (one of the "big three" credit bureaus) made credit scores available online to consumers for a fee of $12.95. To get your credit score, visit http://www.myfico.com or http://www.equifax.com or http://www.scorepower.com.

A few other companies have also made credit scores available to consumers. Trans Union provides your credit score (at no extra charge) when you order a credit report. Experian also offers a credit score product for $12.95. And, depending on the state you live in, you also may be able to get your credit score from other companies. If you live in California and are shopping for a mortgage, the lender must provide you with your credit score. Several other states also require that credit scores be disclosed. Finally, Congress has been considering making disclosure of credit scores mandatory nationwide.

If you get your credit score from one or more credit scorer, keep in mind that your score may vary from one scoring company to the next.

Improving Your Credit Score

If you want to improve your credit score, take the following steps:

• pay your bills on time
• update old accounts (accounts reporting a balance may have been paid down to zero)
• don't max out your credit lines
• limit the number of times you apply for credit
• maintain your accounts for a long period of time, and
• stay away from finance companies.

Finally, you should not give up hope just because you have a low score. If you think the problem is caused by mistakes on your credit report, you should get a copy of your credit report, fix the problem and explain the situation to the lender. Most lenders will override credit scores if they think you are a good risk despite problems with your score.