Friday, April 5, 2013

Credit Scores 101 - Your Credit Score Explained

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One of the most important tools for monitoring your financial health is your credit score. Whether you are in the market for a new home, car, or credit card, your credit score is the measurement used by creditors in making decisions on whether or not to extend you credit. Your credit score and credit report can also help you maintain a watchful eye on any red flags that may signal identity theft or credit fraud. Knowing what your credit score is and how it is comprised is essential knowledge for anyone wanting to stay on top of their finances. 

FICO Score


Your credit score, commonly referred to as your FICO score, is the industry standard used by more than 90% of creditors in determining a borrower’s credit-worthiness. Your FICO score is a composite of information derived from the three main credit-reporting agencies. It gets its name from the Fair Isaac Corporation, which introduced the scoring system in the 1960’s. It places individuals on a range from poor to excellent. The bottom of the range is a score of 300 and the top score possible is 850. Most individuals’ scores obviously fall somewhere in between. 

Deciphering Your FICO Score


According the myfico.com website, the FICO score has five main components: Payment History, Amounts Owed, Length of Credit History, Types of Credit, and New Credit. At 35%, Payment History makes up the largest factor of your score. As the name would suggest, it lists payment history on any agency account reporting to the credit bureaus. It tells lenders whether or not you've made past payments on time.

Amounts Owed comprises 30% of your score. This presents a picture of how much debt you have outstanding. Amounts Owed allows lenders to see red flags that indicate a borrower may be getting overextended and, as a result, could have issues making timely payments in the future.

Length of Credit History is 15% of the score. A longer history will typically have a positive effect on the score. By having a longer history, lenders are better able to gauge your ability to maintain good credit over a longer period of time.

New Credit and Types of Credit Used each comprise 10% of the score. New Credit takes into account how many recently opened accounts you have, and may penalize you if you are accessing too much credit. The Types of Credit Used category looks for a healthy mix of revolving credit, equity accounts, and long-term credit. Too much revolving credit (think credit cards) can be a red flag and result in your score being reduced.

How to Access and Monitor Your Credit Score


There are several ways to gain access and to monitor your credit score and your credit reports. You are entitled to pull your credit report once annually for free through the annualcreditreport.com website. You can use several free services to monitor your score; these include CreditKarma and Credit Sesame. Some credit cards or equity loans will even provide a credit monitoring service free of charge and you can always pay one of the credit reporting agencies directly to have access to both your score and your credit report. These are typically available for a monthly fee.


Your credit score is much more than just a number. A good score allows you access to lower interest rates that can save you hundreds, even thousands of dollars over the life of a loan. It can also help you avoid having to put down large security deposits or down payments. Credit fraud can be readily detected if you stay on top of your credit reports, and a good credit score provides you the flexibility to access your credit, and is an indication of your overall financial well being. Knowing your score is essential whether you use one of the paid credit monitoring options, or one of many free tools.

Alan Dock is an ardent finance buff, and gets many of his smart money tips from credit check sites and investment blogs.


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