debt

How credit scores are calculated

Fair Isaac says there are five factors that influence your FICO score.

5 factors that influence your FICO score:

Payment history: 35 percent. The bad news: While regular, on-time payments will keep your score high in this category, just one slip up can undo a lot of your hard work. "Being 30 days or later on one account can cause your score to dip as much as 100 points," says Cunningham.

Amounts owed: 30 percent. Surprisingly, the amount of your income does not impact the typical FICO score (though some creditors will ask for the information for their own models). Instead, the formula looks at how much you owe and compares that against your credit limits, says Watts. Want a better score? Keep that number at or below 25 percent, says Janet Garkey, special materials editor with the Credit Union National Association's Center for Personal Finance. Ever hear the rumor that lenders will be upset if you have a lot of credit that you can tap? It's not entirely false, says Watts. While your FICO won't be affected if you have large amounts of credit available, "some lenders may raise their eyebrows," he says.

Length of credit history: 15 percent. This is the one category over which you really have no control. Lenders want to know how long you've been playing the credit game -- and as far as they're concerned, the longer the better. For creditors, time equals stability. So if you have a good long-term history with a credit card, even if you're not using it, this could be a good reason to keep it open and active.

Interest in obtaining new credit: 10 percent. So how do they know that you're looking for credit? They keep a record of every time someone looks at your credit report. These requests to see your history are known as "inquiries." But there are two kinds, and it pays to know the difference. A hard inquiry is when you actually apply for credit and the potential lender pulls your report. That will actually lower your score. While there seems to be no hard and fast rules for just how much it could hurt you, it's best to avoid hard inquiries if you're about to go shopping for a home or auto loan. (Fun fact: If you're shopping for a mortgage, all the mortgage-related hard inquiries within a two week period will be treated as one -- allowing you to shop around for the best deal.) The same is true if you're hunting for a car loan or home equity loan. If you're not actually asking someone to consider you for a loan, that's called a "soft inquiry." Some examples: a current creditor wants to look at your report; you ask to see your own credit history or a potential creditor wants to scope you out without your permission. Soft inquiries don't affect your score because they do not indicate you're out shopping for more debt. To keep your score high, apply for credit only when you need it. If you're getting ready to make a big purchase, like a home or car, hold off on applying for other types of credit. "You don't want to have lots of activity before you make a major life purchase," says Steven Katz, spokesman for TransUnion, one of the three major credit bureaus.

Mix of credit/miscellaneous: 10 percent. This is kind of a catch-all category, says Watts. But the main factor to analyze is whether your financial history shows a mix of different kids of loans, like mortgages, revolving loans and installment loans. If it does, you demonstrate that you can "responsibly manage more than one type of credit," says Watts.

Your best score

One thing many consumers may not know: Your scores also can vary depending on which bureau the lender contacts. That's because not every credit issuer will necessarily report to every bureau, so the information used to calculate a score could be different.

"A pretty savvy consumer will know all three scores" and will apply for a card that uses the best score, says Arnold.

As careful as creditors and credit bureaus are, mistakes happen. So if you're thinking about making a big buy where a few percent in interest can mean thousands in (or out) of your pocket, pull your credit history and buy your score well in advance.

Allow at least three to six months before you start shopping, says Katz. That way, if you find an error, you've got plenty of time to get it cleared up before a potential lender sees your report.

Says Katz, "Don't wait until immediately before the purchase."

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