Importance Of Understanding Credit Scores And Credit Reports

Your credit score is based on a numbering system established by major credit bureaus and banks. Unfortunately most people do not have an understanding of credit scores or how they are calculated or who calculates them.

One example is your FICO score. The Fair Isaac Corporation is responsible for this score and although the actual formula used to determine the score is not known outside of Fair Isaac, the consensus is its closely based on the following percentages.

  • 35% is based on punctuality of payment(s) in the past (30, 60, 90 Days Past Due)
  • 30% is determined by the amount of debt, expressed as a comparison ratio between current revolving debt and total available revolving credit limit
  • 15% of the score is based on length of credit history
  • 10% depends on the types of credit used
  • 10% of your FICO score is determined by the amount of credit obtained recently and the recent attempts to secure credit

A score of 750 is considered above average. A score of 650 or less these days usually causes concern for most lenders. Some in live score fact, will not extend a loan to someone with such a score.

Because your credit score(s) can come from 3 different sources, they can vary greatly by 5 to 120 points. Some lenders take the average of your scores from different credit bureaus to determine your credit worthiness. Having one or two scores much lower than the other(s) can greatly affect your creditworthiness in the eyes of the lenders.

For some creditors, your score is the main factor in their deciding whether or not to approve you for a loan. Many creditors and lenders use your credit score as a “hard line” in deciding whether to extend credit or not. In other words, no matter what other factors are involved, borrowers under a certain score will not be given loans. For others, your credit score is just another factor along with job history, annual net income, a proper business plan (for businesses seeking loans), and credit and personal references.

It’s important to know that other institutions such as large banks and major creditors use their own formula in deciding your score. Many banks us a formula customized to their current financial situation and the number of defaults on loans they’ve had to absorb over the past calendar year. As always, the scoring system they create benefits them more so than their customers.