What is a Credit Score and How is it Used?

Your credit score is a three digit number between 300 and 900 which is one factor in determining whether you will be approved for a loan and the interest rate you will be charged. Originally developed by the Fair Isaac Company, the score is usually referred to as your Fico Score. The higher your credit score the more likely you are to be approved for credit and the lower your interest rate will potentially be over the life of the loan.

The fico score is a combination of several factors which are weighted and then combined together to develop the total number. The average credit score in the US is around 678. If you are above this number you stand a better chance of getting the loan you want on your terms than if you are below this level. A score below 580 indicates a problem risk.

The Fico score is basically weighted in the following way:

  • 35% is based on how well you have handled credit in the past such as did you make your payments on time and were there any collections or bankruptcies. This is a measure of how likely you are to pay back a loan.
  • 30% is calculated using the amount of outstanding debt you have. For example, how much do you owe on your home loan or car loan? Are your credit cards maxed out? How much available credit do you still have.
  • 15% of the score is determined by how long you have had credit. The longer the length of time you have had a credit history the better this part of the score is. This is because it shows a longer history of making payments.
  • 10% is based on how much new credit you have. If you open new accounts this will lower your score for a short time. Also, if several lenders access your credit score this can also cause a problem as it makes it appear as though you have a hard time getting a loan.
  • Lastly, approximately 10% is based on which types of credit you have. You should have several different types such as real estate loans, credit accounts, and installment loans. If you rely solely on credit cards this will not be a positive situation.

So why is your credit score important. First, it can be a major factor in whether or not you qualify for a loan. Second, the interest rate you get for the loan can be affected by your score which can mean potentially thousands of dollars in extra charges over the life of the loan.

Source by Liam Schnieder

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