Credit Scoring Methodology
The methodology for creating credit scoring was originally devised by Fair Isaac Corporation (FICO). While the exact formula is not distributed publicly, industry sources believe that they divide portions of your credit history from the three major credit bureaus into five main categories. Each category may contain data with up to twenty-two different bits of information from each person in the database.
Proprietary formulas divide the relevance and significance of the information into a final score with a ranked breakdown along these ratios:
- 35% - History of Payments
- 30% - Amount of Debt
- 15% - Verifiable Credit History Length
- 10% - Recent Credit
- 10% - Types of Credit being used (installment versus revolving)
It’s not clear how much weight is given to paying your mortgage on time compared to paying your car or credit card on time. It is interesting to note that your actual income is not a factor in creating the ratings since the credit bureaus do not have access to this information.
Types of Credit
The two primary types of credit available to consumers are revolving and installment credit. The most common revolving accounts are credit cards which normally carry a maximum amount that you can borrow against. The credit is continually targeted to the maximum as long as the balance is paid down according to the payment schedule. You can pay a minimum amount each month, a greater amount, or pay the outstanding balance and avoid finance charges. There is no set schedule of payments or payment amounts. Installment credit is granted in a lump sum and is paid back over a specified time in gradual payments, and may carry a fixed or variable interest rate. It does not replenish like a credit card as the balance is paid off. Examples of installment credit are home mortgages and automobile loans.
Video: How to Improve Your Credit Score
Building Credit
The best way to build your credit with a credit card is to use it regularly but lightly, without exceeding 30% of the maximum limit. This will establish your ability to manage your credit and to continually pay down the balance. Charges greater than this level will not improve your credit score. Credit cards from stores do not contribute as much to your score as MasterCard or Visa, but they are fairly easy to obtain and can help get you started.
Installment loans are
either unsecured or secured with collateral. Home mortgages secured by the
house and real estate will improve your credit score if the payments are
consistently made on time. If that isn’t possible, then a smaller auto or
student loan is a good way of getting started on building a good rating. These
types of loans contribute significantly toward your rating since they are
usually used for costly items that would not normally qualify for most credit
cards.
As noted in the next section, payment history is the most important component of your overall credit score. Failure to make required payments on time will quickly erode your score. The result will be difficulty in obtaining any new credit, as well as higher interest rates on credit that you may be granted.
Credit Scores
Credit scores are used to determine how much credit you might get, and how much you will have to pay for it. The difference between a top score and a low one can make a difference of as much as 5% in the interest rate you may be offered. Credit scores range from 300 to a perfect 850. This allows lenders to quickly determine how risky you may be as a potential borrower. Those with scores above 700 are usually charged relatively low rates while those with scores below 600 are usually charged higher rates. If the score is low enough, borrowing may be virtually impossible. You can check your score by contacting one of the credit reporting agencies such as Experian or Equifax.
What you should do
Video: How credit cards work
The bottom line to maintaining a good credit rating is to pay all your bills in a regular, timely manner following the creditor’s terms and conditions. When possible, pay them ahead of schedule to minimize the total interest due. Also, don’t overextend your credit obligations beyond what you need to maintain the lifestyle you can afford. It’s also wise to plan your purchases of large ticket items so that you are not simultaneously burdened with multiple loans. Your goal should be to exercise sound debt management and keep your score well above 620, which is a break point for many lenders. The median score in the United States typically hovers around 700+.
Relevant Points of Contact
Community Credit Counselors, Inc.
101 N. Lynnhaven Road, Suite 303
Virginia Beach, VA 23452-7523
800-531-5124
Consumer Credit Counseling Service of Greater Atlanta, Inc.
100 Edgewood Avenue, Suite 1800
Atlanta, GA 30303
866-672-2227
Consumer Credit Counseling Service of Greater San Antonio
6851 Citizens Parkway, Suite 100
San Antonio, TX 78229
210-979-4300
Consumer Credit Counseling Service of Orange County, Inc.
1920 Old Tustin Avenue
Santa Ana, CA 92832
888-289-8230
Consumer Credit Counseling Service of San Francisco
595 Market Street, Suite 1500
San Francisco, CA 94105
800-777-7526
Stores Offering Credit Cards
Target 888-755-5856
Home Depot 800-553-3199
Lowe’s 800-444-1408
Macy’s 877-493-9207
Neiman Marcus 800-685-6695
WalMart 877-294-7880
Circuit City 800-503-1430
Best Buy 888-237-8289
Kohl’s 800-564-5740
Sears 877-319-7904
Abercrombie & Fitch 800-695-9583
Sam’s Club 800-964-1917
JC Penney 800-542-0800
TJ Maxx 800-926-6299
Bloomingdale’s 800-950-0047
