Understanding Credit

Think of "credit score" as a generic term that is used to refer to the numeric value given to your credit history. Most scores provided by the 3 credit bureaus are produced from software developed by FICO in addition to their own proprietary formulas. Since we cannot see each company's exact formula, it's hard to pinpoint the specific differences. However you will notice that you have a different score with each of the 3 companies. The score provided by FICO is not only the basis used for calculating credit scores by the 3 major credit bureaus it is a single formula that is more comprehensive. Creditors and lenders use the credit score from the company they have a business relationship with. It could be a credit bureau's credit score, the FICO score, or the lender's own credit score. The only way to find out is to have your lender tell you (some will not).

There're just too many different credit scores out there for you try to improve all of them individually. If you're working on improving your credit, use the FICO score as your basis. If you focus on bringing up your FICO score, the credit scores from the 3 major credit bureaus will come up as well.

"FICO scores provide the best guide to future risk based solely on credit report data. The higher the credit score, the lower the risk. But no score says whether a specific individual will be a "good" or "bad" customer. And while many lenders use FICO scores to help them make lending decisions, each lender has its own strategy, including the level of risk it finds acceptable for a given credit product. There is no single "cutoff score" used by all lenders and there are many additional factors that lenders use to determine your actual interest rates. However you can now see what interest rates lenders typically offer consumers based on FICO score ranges." ~myFICO.com

The following is information on how your credit is calculated is provided by About.com. Though this information is not definitive it is accurate and comprehensive:

How your credit history is scored.

How Your Credit Score is Calculated

Understanding Your FICO Score and How it Affects Home Buying
Home buyers who are seeking a mortgage find out early-on that their credit score plays an important part in the home buying process and in determining the interest rate that a lender offers.

What is a credit score?

A credit score is a number that lenders use to estimate risk. Experience has shown them that borrowers with higher credit scores are less likely to default on a loan.

How are credit scores calculated?

Credit scores are generated by plugging the data from your credit report into software that analyzes it and cranks out a number. The three major credit reporting agencies don't necessarily use the same scoring software, so don't be surprised if you discover that the credit scores they generate for you are different.

Why are credit scores sometimes called FICO scores?

The software used to calculate a great number of credit scores was created by Fair Isaac Corporation--FICO.

Which parts of a credit history are most important?

The pie chart above right shows a breakdown of the approximate value that each aspect of your credit report adds to a credit score calculation. Use these percentages as a guide:

35% - Your Payment History
30% - Amounts You Owe
15% - Length of Your Credit History
10% - Types of Credit Used
10% - New Credit

Your Payment History Includes:

* Number of accounts paid as agreed
* Negative public records or collections
* Delinquent accounts:
1. total number of past due items
2. how long you've been past due
3. how long it's been since you had a past due payment

What You Owe:

* How much you owe on accounts and the types of accounts with balances
* How much of your revolving credit lines you've used--looking for indications you are over-extended
* Amounts you owe on installment loan accounts vs. their original balances--to make sure you are you paying them down consistently
* Number of zero balance accounts

Length of Credit History:

* Total length of time tracked by your credit report
* Length of time since accounts were opened
* Time that's passed since the last activity
* The longer your (good) history, the better your scores

Types of Credit:

* Total number of accounts and types of accounts (installment, revolving, mortgage, etc.)
* A mixture of account types usually generates better scores than reports with only numerous revolving accounts (credit cards)

Your New Credit:

* Number of accounts you've recently opened and the proportion of new accounts to total accounts
* Number of recent credit inquiries
* The time that's passed since recent inquiries or newly-opened accounts
* If you've re-established a positive credit history after encountering payment problems
* In general, checking to make sure you aren't attempting to open numerous new accounts

Credit scoring software only considers items on your credit report. Lenders typically look at other factors that aren't included in the report, such as income, employment history and the type of credit you are seeking.

What's a Good Credit Score?

Credit scores (usually) range from 340 to 850. The higher your score, the less risk a lender believes you will be. As your score climbs, the interest rate you are offered will probably decline.

Borrowers with a credit score over 700 are typically offered more financing options and better interest rates, but don't be discouraged if your scores are lower, because there's a mortgage product for nearly everyone.

Here's an look at credit scores among the US population in 2003:

Up to 499: 1%
500 - 549: 5%
550 - 599: 7%
600 - 649: 11%
650 - 699: 16%
700 - 749: 20%
750 - 799: 29%
Over 800: 11%

Multiple Credit Scores

Your bank will pull credit reports and scores from all three major credit reporting agencies: Transunion, Equifax and Experian. They'll probably use the middle score to work your loan application. Ask your lender to explain which credit scores will be used and how they affect your loan application.