2016-03-24

Are you asking yourself, “What is a Good Credit Score and why is it important?” Although credit scores go back all the way to the 1950s, it didn’t become really popular until the 1980s. Today, good credit scores are vital for receiving lower interest rates on car loans, credit cards, mortgages, etc. In a nutshell, a lender views a person’s score as a direct reflection of how financially stable they are.

This guide will clarify the ins and out of credit and credit scores, so one will be able to use this score to their advantage, regardless if they have good standing credit or not.

How Do Credit Scores Work?

Credit bureau scoring is essentially the act of performing a background check on one’s financial history. This is vital in determining whether or not the borrower is likely to pay back the loan. Although credit companies primarily determine a person’s credibility through their credit score, other things such as the person’s bank account status and income are taken into account. In other words, one who has a bad credit score is not necessarily without hope, especially if they aim towards improving their score.

It’s against FCRA guidelines to base credit scores of off gender, race, age or zip code. FICO credit scores usually range from 300 to 850 points. The three main national credit data repositories are Equifax, TransUnion and Experian. These scores, however, are only calculated at the credit bureau. FICO itself isn’t able to determine a person’s credit score.

Pieces of data called scorecards are ultimately used to calculate FICO scores. Keep in mind that this data represents millions and millions of people. Therefore, extremely complex mathematical equations are used to set credit scoring guidelines. Basically, FICO analyzes the financial behaviors of millions of people, finding patterns that represent those who are most likely to pay off a loan, or debt in some cases. However, other factors such as social and economic difference among cities need to be taken into consideration. Both positive and negative financial patterns are considered while calculating a score. Missing a house, car or bill payment doesn’t mean that a person’s credit score will be permanently impacted. Not only is this calculating system a more accurate representation of a person’s financial stability, it gives those who have bad credit an incentive to be financially responsible. One can think of this scoring system as a typical high-school class, where both bad and good grades make up a final average.

Keep in mind that both credit bureaus and average underwriters use the same type of credit information. This eliminates unfair calculations and evens out the playing field. No agency has more access to a person’s credit history than another.

Payment History

One of the things that is used to calculate credit scores is a person’s payment history, which includes things such as public records, collection items and frequency of failed payments.

Debts Owed

Debts used to calculate scores include number of reported balances, average trade balance and the connection between total credit limits and total balances.

Age of Credit History

The overall age of a person’s credit history is a huge factor in determining the final credit score. One who has a relatively young credit history is unlike to get a very high credit score.

Recent Credit

New credit includes any new accounts that have been opened up within the past year, along with the amount of time elapsed since the most recent inquiry.

Types of Credit

In certain cases, credit is broken up into several categories, including mortgage, auto loan, bank/credit card, travel and entertainment, gift card, finance company references, installment loans and more. Having a personal finance company reference is a huge benefit for one to have under their belt.

Different Credit Score Ranges

Just about everyone has heard the terms ‘bad’ and ‘good’ credit, but they don’t really know which range is considered bad or good, along with the capabilities of each range. Keep in mind that there’s no written-in-stone benefits for each score range, as this will entirely depend on the business lending out the money. With that said, there are some common, universal advantages that come with each credit score.

FICO scores are typically based on a range from 300 to 850, whereas other score types differ somewhat in range, with some ranges being as low as 150 and as high as 990. Anything about a 700 is typically considered a good credit score, with an 850 being a perfect score

Credit Score Chart:

Excellent Credit: 750 and up

Good Credit: 700-749

Fair Credit: 650-699

Poor Credit: 600-649

Bad Credit: Below 600

Now that the individual credit score ranges have been made clear, some benefits of each range will be mentioned, starting with excellent credit. One who has excellent credit will usually have a large number of options. In most instances, these people can finance a car or credit card at zero percent, along with plenty of more options. The ‘bad’ range, on the other hand, won’t qualify anyone for credit without paying high interest rates, down payments, collateral or a combination of many things, along with strict contracts. The ‘poor’ range may get someone qualified with slightly lowered interest rates and less contract guidelines. People that have ‘fair’ credit will typically get decent interest rates, but not without a down payment. ‘Good’ credit will more than likely qualify someone for low interest rates without a down payment. Again, nothing is set in stone and policies are entirely up to the lender, or business.

How Credit Scores are Determined

Payment History: 35 Percent

Almost near half of a person’s credit score is based off of their payment history, usually consisting of credit card, retail, installment loan, mortgage loan and finance company accounts. Also, main events, such as a person’s bankruptcies, judgments, liens, suits, wages and collection items, are considered while calculating a person’s payment history. Although analyzing one’s collection items may seem pointless, it actually gives credit companies leverage by using the person’s collection item as collateral. If a person’s collection item is valuable enough, they may get the entire loan, regardless of where their credit score stands. Not only are late payments investigated, but the amount owed, deadline duration and date of failed payments are investigated as well. Accounts that show absolutely no late payments heavily influence a person’s credit score in a positive way.

Debts Owed: 30 Percent

Another good portion of credit calculations include the the amount and types of debts that a person owes. Even if a person has bad credit, they can still gain trust from credit companies by having a few or several accounts with lots of money. Although the person may be less likely to pay off a debt or loan in time, they’re more than likely to pay it eventually because of the amount of money they have.

This score takes the total amount owed on all accounts into consideration. The total balance on one’s most recent statement is what usually goes into credit reports. However, the specific types of accounts and how much is owed on each one is calculated into this score as well. Interestingly, a person that missed payments yet has a low account balance is generally considered trustworthy, especially if most of the money went toward payments. A person who doesn’t pay payments yet has a good account balance, on the other hand, is likely to be considered untrustworthy.

Age of Credit History: 15 Percent

As already mentioned, longer credit histories tend to earn a higher credit score. This doesn’t mean that one with short credit history can’t earn good credit, however. First off, the total age of all the person’s accounts is taken into calculation. Note that the age measures the actual age of each account, so multiple accounts can mean longer credit history. Aside from the total age, the age of each individual account is checked as well, since certain types of accounts may qualify for better credit. Also, the time period between the last time the person had an active account is important as well. For instance, one who has had good-standing active credit accounts most of their life and stops using the accounts is likely to see a small drop in their credit score. In some cases, this can be overlooked by credit companies, depending on the amount of time passed since an account was last active.

New Credit: 10 Percent

One of the main reasons why credit companies consider new credit beneficial for credit scores is because opening new accounts requires a level of risk. This is especially true for those who have short credit history. However, do keep in mind that this short-term credit gain tactic may prove counterproductive later down the road if the person takes on more accounts than they can afford.

Overall, this category is scored by the total number of new accounts, how long they’ve been open, number of credit requests and other things of the like. Credit checks that are done for the sake of confirming accuracy don’t count. Also, the last time that a person had a credit report inquiry factors in as well. Although on-time payments are the most beneficial for credit scores, consistent late payments will also somewhat count. Most importantly, the overall credit of these accounts must be decent as well. Whether one wants to build credit through having multiple accounts, long-term accounts or a combination of both, they should make sure that they don’t take on too much financial responsibility.

Credit Type: 10 Percent

Another small portion of one’s credit score involves the type of credit in use. The overall ratio of credit, retail, installment loan, finance company and mortgage accounts is the ultimate determining factor for this grading portion. However, having all of these accounts doesn’t guarantee a good credit score, especially if the person doesn’t plan to use one or more of the accounts. Naturally, bigger accounts will tend to earn higher scores. Good-standing installment loan accounts heavily increase this portion of one’s credit score as well. Having too many accounts can be counterproductive, as some look at this as a sign of bad decision making, given that the accounts are not in good standing. Other types of credit include non-resolving, resolving, secured, unsecured and short term loan credit. Mortgages, auto and student loans fall under the unresolved category. Secured credit, on the other hand, almost always involves some sort of collateral, such as a collection item. For instance, one who doesn’t pay their car payments doesn’t have to worry about interest, fines or even jail time, as their car will simply be repossessed.

Reason for Given Credit Score

Even after reading all of the above, one may still be surprised when they check out their credit score, wondering what went wrong. Although credit scoring is a very complicated process, there are four main reasons, or codes, for why a person got the credit score they have. These codes are required by regulations to be included in each and every credit report. It’s also important to know that these four codes don’t outline the positive aspects of one’s credit score, but rather the negative aspects. For instance, one may see this upon looking at their credit score: too many late payments, credit history too short, too much time elapsed since last active account and high-dollar debts. Again, these codes only explain why the person didn’t receive a better score. Note that seeing these codes doesn’t necessarily mean one has a bad score. Even people who have the highest credit scores still see these four codes showing why they couldn’t score even higher. Only the most significant factors are included into these codes, so the codes don’t explain absolutely everything.

How Credit Inquiries Impact Credit Scores

A credit inquiry is nothing more than a request on a credit report that records a business’s requested credit report. Anytime that a person’s credit score and overall history is checked, a credit inquiry is recorded. There’re two primary types of credit inquiries: hard and soft. A car dealership requesting a person’s credit report would be considered a hard inquiry since the person originally initiated the credit report request by renting a car. Hard inquires have an impact on the person’s credit score, whereas soft inquires don’t. Some examples of soft inquires include the consumer requesting a credit report themselves or some other third-party requesting a report for reasons other than confirming the person’s financial stability. Only businesses that have been approved by the federal Fair Credit Reporting Act can request someone else’s credit report. Aside from soft and hard inquires, there are two other types: mortgage and auto loan inquiries. Both mortgage and auto loans tend to cause a person’s credit to be checked more often. As a result, any additional credit runs will be excluded by credit companies, leaving no impact on one’s credit score. This usually includes additional credit checks that occurred within the last 30 days. However, the initial credit check will count towards the credit score.

Various Credit Rating Models

Industry Scores

The three national credit companies mentioned earlier have their own specific guidelines on how things are scored, giving consumers insights on how they can improve their financial and business relationship with that particular credit industry. However, each of the three companies’ grading systems are pretty similar. Fortunately, FICO gives consumers the opportunity to choose between the three industry-type scores for bankcards, auto, installment and finance company lending. Upon requesting an industry-type score, the universal FICO score is calculated. From there, this score is combined with the scorecards of the desired industry. One score card mentions negative aspects of the person’s credit history, while the other scorecard doesn’t. When it’s all said and done, one will see both their FICO and industry-determined score. Both scores are useful for different financial scenarios. The type of credit score an approved business requests depends on what plan they’re trying to make with the consumer.

FICO Scores

As already stated, FICO scores are one of the ways that businesses determine if a person is trustworthy for a loan or not. Now, FICO credit scores are used by a number of different industries and businesses. Most FICO scores are within the 300 to 850 range. The three main types of FICO scores are Equifax, Experian, which is split into two codes, and Trans Union, which is split into the well-know four codes discussed earlier. Although these FICO scores are highly effective at determining financial risk, they’re somewhat limited. For one, these scores tend to leave out other important aspects, such as late payments made, repeated offenses and the like. In some ways, FICO scores are more strict than newer score systems such as FICO 08. However, FICO 08 is stricter in some ways as well. Depending on what the situation calls for, a business may either choose to use an industry-type score, FICO, FICO 08 or some other score.

FICO 08

Although the traditional FICO scores are still highly effective to this day, there are some flaws in the scoring system that have been resolved with newer score types, such as the FICO 08. At a first glance, one may get the idea that FICO 08 grading systems are much more lenient. After all, they’re more forgiving toward those who make late payments. On the same token, FICO 08 scores penalize repeat offenders much more severely than original FICO scores would. However, they do put more attention to those who have multiple credit types. Also, FICO 08 tends to look down on those who use high portions of their credit. Overall, this scoring system doesn’t mind those who make late payments, as long as the consumer doesn’t go overboard. One can rightfully conclude that the FICO 08 scoring system was designed for those with low income, due to the system being more lax on late payments. Furthermore, the system eliminates people with high incomes by penalizing those who use a high percentage of their credit.

Vantage Score

Interestingly, the vantage score was the very first credit system that was created by the three main national credit companies, Equifax, TransUnion and Experian. The scoring system was based off of an analysis of around 15 million people. In fact, a vantage score is essentially the combined score of all three credit companies, hence the name vantage. This gives consumers, credit companies and other businesses a more predictable, accurate scoring system. Unlike most credit scores that range from 300 to 850, vantage scores can be as high as 990. Also, vantage scores are based off of a much longer time period, usually at least 24 months. Much like the FICO 08 scoring system, vantage penalizes those who are late on mortgage payments. Going back to the credit report inquires, FICO excludes additional inquires with a 45-day time frame, while vantage’s timer period is significantly shorter, a mere 14 days. In a way, this can be good news for one’s credit score whenever a credit inquiry is made.

Newer Generation Scores

Just recently, a new scoring system was created by FICO to integrate a variety of changes. All in all, these scores are highly effective at predicting financial behavior. As a matter of fact, these newer generation scores have twice as many, around 80, variables compared to the original FICA scoring system. On top of that, this scoring model uses a total of 18 scorecards, whereas the original scoring system only had 10 scorecards. Similar to FICA 08 scores, the new generation scores have a range between 150 and 950. As one can see, the newer scoring system has a much lower beginning range, unlike many other scoring methods. As of now, FICO offers three types of these new generation scores: Pinnacle, Advanced Risk Score and FICO Risk Score. In summary, these more recent scoring systems revolutionized the very way that credit is scored.

Bankruptcy Scores

In order to determine the likely hood of an individual filing bankruptcy, FICA created a specific scoring system to measure just that. Simply put, this scoring system is based off of the number of times a person filed bankruptcy in their entire life time. Bankruptcy types are as follows: BNI 3.0, Bankruptcy Score and Delphi. Keep in mind that those who started out with excellent credit won’t be affect by bankruptcy nearly as much as someone who started off with bad credit. Also, those who started off with no credit whatsoever will be affected by bankruptcy just as bad. Chapter 7 bankruptcy will stay on record for up to 10 years. Any other type of bankruptcy stays on file for around seven years. Contrary to popular belief, a bankruptcy doesn’t mean that someone won’t be able to have good credit within that 10 or seven-year time frame. It will, however, make it significantly harder to improve both credit and bankruptcy scores.

Click to Download Datasheet on Credit Risk Scores

Getting a Good Credit Score

How to Improve Credit Scores

The best way to improve one’s credit score over time is to pay off credit payment on time. Another nice thing to know is that the impact of negative variables diminishes over time. Because these variables are constantly aging and changing with time, one can never expect their credit score to be the same, even after not committing to anymore credit obligations. In this case, the person’s score will continue to decline as both the negative and positive aspects age. Therefore, it’s important to retain some credit responsibilities. Another effective trick is to transfer funds from one credit account to another. What this does is increase the available credit on that account, which in turn positively impacts one’s credit score. This can, however, prove to be counterproductive in certain cases, so process with caution. On the flip side, keeping a low available balance in one’s credit account may be helpful. However, the only true fire way to improve credit is to fulfill as much credit responsibilities as possible without going overboard. This includes opening different types of credit accounts, applying for loan, mortgages and the like. In a nutshell, it really boils down to disciplining one’s budget and spending habits. Always think about long-term gain rather than short-term pleasure.

Tools for Increasing Credit Score

Beware of websites that claim to fix credit overnight, as some of these websites are complete scams. Just remember that building or repairing credit takes discipline, hard work and most importantly time. Credit industries do offer tools, such as CreditXpert, for correcting credit scoring mistakes. Other helpful tools include Essentials and What-If Simulator. Not only do these tools fix errors, but they give helpful tips to consumers on the different ways that they can improve their credit score. CreditXpert Essentials promotes the idea of pay-downs, opening and closing new accounts, transferring funds between accounts and many more helpful actions. CreditXpert Detective, on the other hand, finds database and credit errors in credit reports. CreditXpert What-If Simulator allows one to safely witness the consequences of different credit actions. The possibilities and outcomes with this simulator are nearly infinite. However, using a combination of all three tools is ideal. These tools combined with patience and good spending habits will drastically improve one’s credit score in time. As always, one can do a quick Google search and find hundreds of different blogs and articles discussing different ways to improve credit scores. With that said, do make sure that the blogs or articles are from credible sources. Most importantly, don’t buy into scams that claim to improve credit scores overnight.

Fixing Incorrect Credit Information

Although not common, a person may run into unfortunate credit errors upon checking their credit score. If errors do happen to be the case, then one needs to not worry since the FCRA, or Fair Credit Reporting Act, gives the credit agency a maximum of 30 days to investigate the situation. However, most investigations are completed within a few days. Overall, credit agencies take these kind of errors very seriously, especially when it comes to identify theft or mortgage decisions. Anyone who believes to have one or more errors in their report should contact either Equifax, Experian or TransUnion. In certain cases, there may only be errors in only one of industry-type scores. Most bankers are able to pinpoint where the credit error originated from. Whatever one does, they should not hold off such an investigation, as doing so can further progress the error, whether from identify theft or some other error. Extreme cases of errors usually require disregarding the credit score all together, starting from scratch. This happens to be the policy that most lenders and investors follow. The three national credit companies mentioned throughout this guide have their own website as well. Here, one can gather all the information they need to fix whatever errors occurred, as well as improve existing credit scores.

Assistance for Filing a Dispute

All credit reports ran through Credo come with a completely free disputation service. When one calls the FCRA, they’ll receive friendly service, telling them how to go about solving the dispute. Upon investigation, Credo will contact all credit agencies and fix whatever errors. Plus, the consumer will be frequently updated about the investigation. Once all the errors have been discovered, they’ll be replaced with correct updated information. This entire process must follow strict time frames and procedures as well. When everything is all said on done, one then requests Rapid ReCheck, which quickly processes the updates. Before one knows it, they’ll receive a credit report showing their most current, correct credit score.

Non-Conventional Credit

Today, credit companies are finding ways to look past credit scores. Because there are a growing number of people today who don’t believe in credit or debt, nor want it, credit companies are beginning to realize that a lack of credit doesn’t necessarily mean a lack of financial trust and responsibility. Many of these people pay their bills on time and have a healthy bank account balance.

As a result, credit companies created something called the Anthem Report from Credo, which analyzes a person’s payment history, such as rent, insurance payments and the like. These payment activities accurately represent a person’s financial stability, if not more. This scoring system is extremely beneficial for younger people, eliminating the need for debt all together. These young people have enough school debts as it is. Perhaps later in the future, there’ll be a universal scoring system that analyzes non-credit payment history.

Non-Conventional Credit Reporting

There are plenty of people today who have no credit history, yet are financially stable. Thanks to Anthem Credo, people can now make non-traditional loans and mortgages. The report is very affordable and doesn’t require one to have any credit history. Obviously, this score is rated very differently than traditional scoring methods. As with traditional scores, one can negatively impact their non-traditional credit score by not making payments on time, over-drafting bank accounts and other negative actions. Most importantly, this system allows people to build credit while avoiding debt entirely.

The Consumer’s Rights

FACT Act

Created by the federal government in 2004, the FACT Act was primarily designed to give consumers the right to access their credit reports and scores upon request, among other things: Each of the three main national credit agencies must provide consumers with a credit report each year. This also includes the removal of incorrect information, especially in identify theft cases. Any information a business receives from a suspected fraudulent person must be notified to the real consumer. Identity theft is a problem that always needs immediate attention.

Free Credit Reports

In addition to the FACT Act, the three main agencies had to offer consumers a free credit report every year upon the consumer’s request. Prior to this new rule, people had to inconveniently wait for their annual report.

Credit Report Does Not Equal Credit Score

A credit report only lists things such as payment history, credit history and the like, not credit scores. If one wants their credit score, they’ll have to request one along with their annual credit report. One can think of a credit score as a quick summary of a credit report.

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