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How credit scores work, how a score is calculated
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"Carrying a lot of debt doesn't necessarily mean you'll have a lower score," Watts says. "It doesn't hurt as much as carrying close to the maximum. People who consistently max out their balances are perceived as riskier. People who never use their credit don't have a track history. People with the highest scores use credit sparingly and keep their balances low."

3. Length of credit history (15 percent)
The third factor is the length of your credit history. The longer you've had credit -- particularly if it's with the same credit issuers -- the more points you get.

4. Mix of credit (10 percent)
The best scores will have a mix of both revolving credit, such as credit cards, and installment credit, such as mortgages and car loans. "Statistically, consumers with a richer variety of experiences are better credit risks," Watts says. "They know how to handle money."

5. New credit applications (10 percent)
The final category is your interest in new credit -- how many credit applications you're filling out. The model compensates for people who are rate shopping for the best mortgage or car loan rates. The only time shopping really hurts your score, Watts says, is when you have previous recent credit stumbles, such as late payments or bills sent to collections.

"Then, looking for new credit will be seen as an alarm because statistically, before people declare bankruptcy and default on everything, they look for a life preserver," Watts says. Also, if you have a very young credit file, an inquiry can count for more than if you've had credit for a long time.

What doesn't count in a score
The scoring model doesn't look at:

  • age
  • race
  • sex
  • job or length of employment at your job
  • income
  • education
  • marital status
  • whether you've been turned down for credit
  • length of time at your current address
  • whether you own a home or rent
  • information not contained in your credit report

A lender may consider all those factors when deciding whether to approve a loan application, but they aren't part of how a FICO score is calculated, Watts says.

Credit scores are not perfect
The major drawback to credit scoring is that it relies on information in your credit report, which is quite likely to contain errors. That's why it's critical that you check your credit reports annually, or at the very least three to six months before planning to buy a house or a car. That will give you sufficient time to correct any errors before a lender pulls your score.

Watts says that the need for accuracy in credit files is one reason why it's good for consumers to learn about credit scores.

"There's a hope that as consumers know about credit reports and scores, they'll do more to correct errors and provide more oversight," he says. "If consumers can police the accuracy of their own reports, everybody gains."

Want to get an approximation of your score? Bankrate and FICO have teamed up to create the free FICO Score Estimator.

Bankrate editorial assistant Leslie Hunt contributed to this story.

Bankrate.com's corrections policy -- Updated: Nov. 8, 2006
 
 
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