In the 1960’s, the Fair Isaac Corporation started working on a system designed to help lenders analyze the probability that they would be repaid on a loan. Fair Isaac sought to develop a system that could dependably predict one’s statistical likelihood of creditworthiness, thus the FICO score was born. The evolution of Fair Isaac’s research became the standard of credit scoring by the 1980’s.
Credit scoring has a tremendous impact on one’s ability to purchase high dollar items such as a home. One’s credit score can determine whether the consumer receives a good interest rate to whether or not one can even qualify for a home. For this reason, consumers should understand how credit scoring works and how it impacts their personal ability to borrow funds.
What the credit scoring model quantifies is how likely the consumer is to repay their obligations without being more than 90 days late. Credit scores can range from 350, which is considered a very low credit score, all the way up to 850, the highest possible credit score achieved. Only 1 in 1,300 consumers will achieve a credit score over 800. Consumers with 800+ credit scores are the most likely to obtain the best interest rates available on the market, effectively saving thousands of dollars in interest. On the other hand, 1 in 8 consumers with credit scores between 500 and 600 face the possibility that they won’t qualify for financing. This is why it’s so important to understand how credit scoring works and how it impacts your financial future.
So how is your credit score derived? Here is a simple guide to help you understand what factors contribute to the composition of your credit scores.
- Payment History: 35% Impact.
- Outstanding Balances Carried: 30% Impact.
- Credit History: 15% Impact.
- Mix of Your Accounts: 10% Impact.
- Inquires: 10% Impact.
Payment History: Paying your debt on time and in full has a major impact on your credit score. Charge off’s, late payments and judgments will negatively impact your credit scores. Missing a higher payment has a more severe impact than missing a lower payment. Delinquencies that have occurred within the last two years carry more weight than older delinquencies.
Outstanding Balances Carried: This factor marks the ratio between outstanding balance and available credit. Ideally consumers should try to keep balances as close to zero as possible. The general rule of thumb is that consumers should keep their balances at or below 30% of their available credit limits.
Credit History: This factor marks the length of time a consumer has had credit. The longer the duration of time a consumer has had credit, typically the stronger the consumers credit scores will be.
Mix of Your Accounts: A mix of auto, credit cards, and mortgages are typically more beneficial to obtaining higher credit scores than solely having credit in just one segment such as credit cards.
Inquires: This represents the number of inquires made on a consumer’s credit history within the last six months. Each hard inquire can potentially cost the consumer from 2 to 50 points to their credit score. The consumer’s credit score can be impacted by the first 10 credit inquires in a six month period however at the 11th inquire; the consumers credit will no longer be impacted.
Having a complete understanding of how your credit scores are derived is essential to making positive decisions regarding the management of your credit. In next week’s article, we will help explain how people with credit challenges can make simple changes that can positively increase their credit scores as much as 100 points in 40 days.
By Eric Fowlston of Desert Hills Bank, Phoenix Arizona – firstname.lastname@example.org, 602-324-6725