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Sunday, 4 August 2013

How Credit Score is calculated?

What affects your credit score?
The credit score is calculated from several different pieces of credit data in your credit report. This data is grouped into five categories as outlined below. The percentages in the chart reflect how important each of the categories is in determining how your Score is calculated. Your Score considers both positive and negative information in your credit report. Late payments will lower your Score, but establishing or re-establishing a good track record of making payments on time will raise your score. 

These percentages are based on the importance of the five categories for the general population. For particular groups—for example, people who have not been using credit long—the relative importance of these categories may be different. The importance of any one factor in your credit score calculation depends on the overall information in your credit report. For some people, one factor may have a larger impact that it would for someone with a much different credit history. In addition, as the information in your credit report changes, so does the importance of any factor in determining your Score.

Therefore, it’s impossible to measure the exact impact of a single factor in how your credit score is calculated without looking at your entire report. Even the levels of importance shown in the Score chart are for the general population, and will be different for different credit profiles. Your credit score is calculated from your credit report. However, lenders look at many things when making a credit decision including your income, how long you have worked at your present job and the kind of credit you are requesting.

1. Payment History (30%)

The first thing any lender wants to know is whether you've paid past credit accounts on time. This is one of the most important factors in a Score. A few late payments are not an automatic "score-killer." An overall good credit picture can outweigh one or two instances of late credit card payments. However, having no late payments in your credit report doesn't mean you’ll get a "perfect score." Your payment history is just one piece of information used in calculating your credit Score.

1A. Credit payment history on many types of accounts: Account types considered for payment history include:- Credit cards (Visa, MasterCard, American Express, Discover, etc.), Retail accounts (credit from stores where you shop, like department store credit cards), Installment loans (loans where you make regular payments, like car loans), Finance company accounts, Mortgage loans

1B. Public record and collection items: These types of events are considered quite serious, although older items and items with small amounts will count less than recent items or those with larger amounts. Negative factors include - Bankruptcies - will stay on your credit report for 7-10 years, depending on the type, Foreclosures, Lawsuits, Wage attachments, Liens, Judgments etc.

1C. Details on late or missed payments ("delinquencies") and public record and collection items: The Credit Score considers:- How late they were, How much was owed, How recently they occurred, How many there are

2. Amounts owed (30%)

Having credit accounts and owing money on them does not necessarily mean you are a high-risk borrower with a low Score. However, when a high percentage of a person's available credit is been used, this can indicate that a person is overextended, and is more likely to make late or missed payments. Part of the science of scoring is determining how much is too much for a given credit profile. Your Credit Score takes into account several factors:-

2A. The amount owed on all accounts: Note that even if you pay off your credit cards in full each month, your credit report may show a balance on those cards. The total balance on your last statement is generally the amount that will show in your credit report.

2B. The amount owed on different types of accounts: In addition to the overall amount you owe, your Credit Score considers the amount you own on specific types of accounts, such as credit cards and installment loans.

2C. Whether you're showing an amount owed on certain types of accounts?: In some cases, having a very small balance without missing a payment shows that you have managed credit responsibly, and may be slightly better than carrying no balance at all. Having a low credit utilization ratio can be better than having a high one, or none at all. For example, closing unused credit accounts that have zero balances and are in good standing will not raise your Credit Score.

2D. How many accounts have balances?: A larger number of accounts with amounts owed can indicate higher risk of over-extension.

2E. How much of the total credit line is being used and other "revolving" credit accounts?: Someone who is close to "maxing out" several credit cards has a high credit utilization ratio and may have trouble making payments in the future.

2F. How much of the installment loan amounts is still owed, compared with the original loan amount?: For example, if you borrowed $10,000 to buy a car and you have paid back $2,000, you still owe (with interest) more than 80% of the original loan. Paying down installment loans is a good sign that you're able and willing to manage and repay debt.

3. Length of credit history (15%) 

In general, a longer credit history will increase your Score. However, even people who haven't been using credit long may have a high Score, depending on how the rest of the credit report looks. Your Score takes into account: 
  • how long your credit accounts have been established, including the age of your oldest account, the age of your newest account and an average age of all your accounts
  • how long specific credit accounts have been established
  • how long it has been since you used certain accounts

4. Types of credit in use (10%) 

The score will consider your mix of credit cards, retail accounts, installment loans, finance company accounts and mortgage loans. It's not necessary to have one of each, and it's not a good idea to open credit accounts you don’t intend to use. The credit mix usually won’t be a key factor in determining your Credit Score—but it will be more important if your credit report does not have a lot of other information on which to base a score.

4A. Have credit cards – but manage them responsibly: Having credit cards and installment loans with a good payment history will raise your Credit Score. People with no credit cards tend to be viewed as a higher risk than people who have managed credit cards responsibly.

4B. What types of credit accounts you have? Do you have experience with both revolving credit and installment type accounts, or has your credit experience been limited to only one type?

4C. How many types of credit accounts? Your Credit Score also looks at the total number of accounts you have. How many is too many will vary depending on your overall credit picture.

4D. Closing an account doesn't make it go away: A closed account will still show up on your credit report, and its history will be considered by your Credit Score.

5. New credit (10%) 

Research shows that opening several credit accounts in a short period of time represents a greater risk - especially for people who don't have a long credit history. Your Credit Score takes into account several factors, including how you shop for credit.

5A. Its OK to request and check your own credit report:
Checking your credit report won’t affect your Credit Score, as long as you order your credit report directly from the credit reporting agency or through an organization authorized to provide credit reports to consumers.

5B. How many new accounts you have? Your Credit Score looks at how many new accounts you have by type of account. It also may look at how many of your accounts are new accounts.

5C. Don't open new accounts too rapidly: If you have been managing credit for a short time, don’t open a lot of new accounts too rapidly. New accounts will lower your average account age, which will have a larger effect on your Credit Score if you don’t have a lot of other credit information. Even if you have used credit for a long time, opening a new account can still lower your Credit Score.

5D. How many recent inquiries you have? An inquiry is when a lender makes a request for your credit report or score. Inquiries remain on your credit report for two years, although the Credit Score only consider inquiries from the last 12 months. The Credit Score has been carefully designed to count only those inquiries that truly impact credit risk, as not all inquiries are related to credit risk.

There are 3 important facts about inquiries to note:- Inquiries usually have a small impact, Many types of inquiries are ignored completely, The score allows for "rate shopping"
MYTH: My Credit Score will drop if I apply for new credit
TRUTH: If it does, it probably won't drop much. If you apply for several new credit cards within a short period of time, multiple requests for your credit report information (inquiries) will appear on your report. Shopping for new credit can equate with higher risk, but most credit scores are not affected by multiple inquiries from auto or mortgage lenders within a short period of time. Typically, these are treated as a single inquiry and will have little impact on the credit score.

5E. Length of time since credit report inquiries were made: 
When you shop for credit, inquiries remain on your credit report for two years, although Credit Scores only consider inquiries from the last 12 months.

5F. How long it's been since you opened a new account? Your Credit Score may consider the time that has passed since you opened a new credit account, for specific types of accounts.

5G. Whether you have a recent good credit history, having bounced back from past payment problems?: Late payment behavior in the past can be overcome; re-establishing credit and making payments on time will raise a Credit Score over time.

I hope this article will help users be more aware of how the credit score is calculated, why the credit score is important and get more vigilant to credits!! Cheers and do leave your comments!!

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