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How is a Credit Score Calculated?

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A FICO score has been the critical element in determining one's financial health. Consumers have heard numbers bantered around for years, but until this point they may have been completely unaware of what impact their spending behaviors have on their credit rating.

The Fair Isaac Corporation of Minneapolis is the creator of the FICO score. Engineer Bill Fair and mathematician Earl Isaac founded the company in 1956. By 1970, these two men helped deliver the most widely used credit score rating system in the world.

Weighing certain consumer behaviors higher than others result in a score ranging from 300-850. What number you have often determines the amount you have to pay to borrow money from lenders, or whether lenders will lend to you. There are five elements that currently make up your FICO score:

  1. 35% Based on repayment history or how diligent and timely a consumer has been in paying back debt
  2. 30% Based on Credit Utilization Ratio or how much available credit a consumer has in relationship to what they are actually using at any given time
  3. 15% Based on average length of available credit or how long a consumer has had various credit accounts in place
  4. 10% Based on diversity of one's available credit line, from mortgages, to credit cards to personal loans, this all counts
  5. 10% Based on inquiry history. Every time consumers apply for new credit an inquiry is made into your account
This information is collected and ranked by the three major Credit Reporting Agencies (TransUnion, Equifax and Experian). Whenever a consumer applies for credit of any type, this information is reported back to the lender making the inquiry. As a consumer, it is important to be aware of your number as it can cost or save you tens of thousands of dollars during your lifetime. Changes to Credit Scoring in 2009 2009 marks the year when Fair Isaac tweaked their equation to further fine tune the FICO scores assigned to people. This adjustment is occurring in order to meet the changing economic realities of the times to be more responsive and a better indicator of credit-risk scenarios for lenders. As of August, the new scoring system is rumored to be in use; however, no official announcement has been made. The changes did not affect the above percentages for how the score is formulated. In summary, these are the changes:
  • Effects of authorized-user accounts on credit scores have been reduced, but not eliminated
  • Higher penalties for late payment
  • Higher rewards for prompt payment
  • Different debt will be scored differently

The new formula is more strict on credit users to reflect a more risky lending environment. For years the hardest credit behaviors to predict were those who scores were in the 600 range. The tweaking of the formula will now weigh the overall damage and quantity of the economic misteps so lenders will more easily be able to separate the repeat credit offenders.

You can check your credit score for free once per year at annualcreditreport.com, or you can subcribe to a service like GoFreeCredit.com to regularly check your credit report and score.

Provided by Credit at Go Banking Rates.


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