These days a lot of importance is attached to credit report scores. At one time credit report scores were only used by banks and financial institutions to determine borrower risk. However, in recent times even landlords, insurance companies, utility companies and employers refer to these credit scores.
Credit scores are used not only to judge the likelihood of repayment of debt but also the rate of interest to be charged. The method of determining borrower credibility has come a long way from using personal opinions to developing models using statistical techniques based on certain variables. Credit report scores are a culmination of these statistical methods.
The FICO model of credit scoring was developed by Fair Isaac Inc. and was licensed to all the three credit bureaus (namely Equifax, Transunion and Experian). Each of these has created their own variation of the FICO scores. Typically, the scores range from 300 to 850 with high scores indicating high borrower credibility whereas the low ones depict a greater risk of default.
The five key factors that are used to determine credit scoring are payment history (35%), total amount of debt (30%), length of credit history (15%), new accounts (10%) and type of credit (10% ).
Obviously, lenders are interested in your past payment record. This includes your payment patterns of credit cards, loans, mortgages, utility bills etc. If you pay your bills and credit card dues promptly and regularly, your credit scores stand to rise. Late payments bring them down. Here, more consideration is given to the past twelve months delays in payments as compared to delays in payments that may have occurred three or four years ago. Bankruptcy and collection suits can cause your credit report scores to plummet.
Total Amount of Debt
The total amount that you owe across all kinds of debt is also considered while calculating credit scores. If you have used all the available balance on most of your credit cards, this shows your inability to manage debt responsibly and suggests you are in over your head. The amount owed in relation to the limit on your accounts is used to determine your credit score. The lower the ratio the better as far as your credit score is concerned. Having no debt at all will also not guarantee a higher score. The scores are favorable to those who use credit but manage it responsibly.
Length of Credit History
If you have been using credit sensibly for a long period of time, your score automatically increases. If you have just recently started using a credit card, odds are that your credit score will increase only once your account gets older and you show reliable credit behavior. So, the longer you use credit, the better your credit score.
Getting too many credit cards all at once may put you in a high risk category. Even inquiries made for information from the credit bureaus are listed in your credit report and have a bearing on your scores. Any new inquiries made in the past 12 months will cut a few points off your credit score. However, these inquiries refer to only those made in accordance with credit that you've applied for and not rate-shopping, utility companies, prospective employers and pre-approved offer inquiries.
Type of Credit
Credit scores increase if you have a healthy blend of different types of debt. The type of credit you have used indicates responsibility or recklessness in managing different kinds of credit. Typically, scores rise if you sensibly utilize a combination of revolving (credit cards) and installment credit (loans).
All the above-mentioned factors contribute to determining your score. So, if your credit report score confuses you, at least you will be aware of the factors that influence it.