How credit scores work, how a score is calculated

Ever wonder why you can go online and be approved for credit within 60 seconds? Or get prequalified for a car without anyone even asking you how much money you make? Or why you get one interest rate on loans, while your neighbor gets another?

Your credit score is a number generated by a mathematical algorithm -- a formula -- based on information in your credit report, compared to information on tens of millions of other people. The resulting number is a highly accurate prediction of how likely you are to pay your bills.

If it sounds arcane and unimportant, you couldn't be more wrong. Credit scores are used extensively, and if you've gotten a mortgage, a car loan, a credit card or auto insurance, the rate you received was directly related to your credit score. The higher the number, the better you look to lenders. People with the highest scores get the lowest interest rates.

Scoring categories
The scale runs from 300 to 850. The vast majority of people will have scores between 600 and 800. A score of 720 or higher will get you the most favorable interest rates on a mortgage, according to data from Fair Isaac Corp., a California-based company that developed the credit score. (Its own score is called the FICO score.)

Fair Isaac reports that the American public's credit scores break out along these lines:

 Credit score Percentage 499 and below 1 percent 500-549 5 percent 550-599 7 percent 600-649 11 percent 650-699 16 percent 700-749 20 percent 749-799 29 percent 800 and above 11 percent

What's the big deal?
Your credit score will determine if you get credit at all, and the interest rate on that credit, says Ed Ojdana, president of Experian Consumer Direct, part of Experian, the largest of the three major credit-reporting agencies. "The better the score, the lower the interest rate and that can save you a ton of money."

The difference in the interest rates offered to a person with a score of 520 and a person with a 720 score is 3.45 percentage points, according to Fair Isaac's Web site. On a \$100,000, 30-year mortgage, that difference would cost more than \$85,000 extra in interest charges, according to Bankrate.com's mortgage calculator. The difference in the monthly payment alone would be about \$235.

Powerful little number
If you rented an apartment, got braces, bought cell phone service, applied for a job that involved handling a lot of money, or needed to get utilities connected, there's a good chance your score was pulled.

If you have an existing credit card, the issuer is likely to look at your credit score to decide whether to increase your credit line -- or charge you a higher interest rate, according to a credit scoring study by the Consumer Federation of America and the National Credit Reporting Association.

Buying a car? Most car dealers want to know your credit score when you walk in the door, says Bob Kurilko, vice president of marketing and industry communications for Edmunds.com, an online consumer resource for automotive issues. "They want to know how they can put a loan together for you."

The score has made it easier for many people to get credit, Kurilko says.

Next: Until recently, many Americans didn't even know this number existed.
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