Check My Credit Score For Free
Consumers depend on credit for many important things in life, from buying a home or automobile to qualifying for a student loan. The three digit number that makes up your credit score is so simple, yet affects so many things -- like what lines of credit you qualify for and what interest rates you are charged.
How can a few numbers decide whether you can buy a car or home? Your credit report is a detailed record of your financial history. It details your bill payment history, how much open credit you have, and many other facts that help potential lenders make a decision about your credit worthiness. Basically, a credit score is all of this information represented as a number. Credit scores are used by lenders to judge the chances that an applicant is financially responsible will be able to repay a loan.
Your credit score plays a factor in how much you pay for credit, insurance, and other life necessities. In the past credit scores were not available to the public. Until recently, only banks and other businesses that utilized credit scores were granted access. The company which developed the credit score, Fair Isaac and Company, believed that the general public would be confused by the scores because they would not know what it meant, and they did not know what lenders were looking for in a potential borrower.
Due to pressure for the US Congress as well as consumer and business action groups, in 2001 consumers were given access to their credit scores. Credit monitoring and reporting agencies are now happy to tell you your score... for a fee.
In order to understand, and if necessary, improve your credit score you must have the knowledge of how it is calculated.
What goes into a credit score? Why should I check mine?
Credit scores are calculated based off of information in your credit report.
Many scoring systems exist, but the majority of lenders use the FICO system developed by the Fair Isaac Corporation. In the early 1980s Fair Isaac worked with the three major credit reporting agencies (TransUnion, Equifax, and Experian) to create the system.
Calculating a credit score is similar to the way a teacher calculates a students grade for a class. Teachers combine homework, exam scores, attendance and any other criteria they want to use and weigh each component (based on how important they feel it is) in order to determine a final score. This is how a credit score is calculated, though instead of using test scores and essays, the contents of a persons credit report is used.
Credit scores range from 300 to 850. The exact formula used to calculate the score is not available to the public, but below is a close approximation of how a score is determined:
35% of the score is based on payment history. This is appropriate because one primary reason a lender would look at someone's credit score is to establish if they pay their bills on time. This portion is calculated based off of how often debts are not paid on time, how often (if ever) debts were sent to collection agencies, and if any debts resulted in bankruptcy. The timing of these events are also considered. The more recently a negative event occurred, the bigger affect it will have on a credit score.
30% is calculated based upon how much outstanding debt a person has. Money owed on mortgages, auto loans, and credit cards is considered. Also considered is if credit cards are at, or near their limits. Creditworthiness is greatly impacted by having credit cards that are at their limits, and the more there are, the worse it is. A great rule of thumb is to keep all account balances at less than 25% of the limit.
15% is based upon how long you have had your sources of credit. The longer the better, this is because having a lot of information in your credit report detailing previous payment history show lenders that you may be a safe bet to repay the money lent to you.
10% of credit scores are determined by new credit. Opening new lines of credit will cause your credit score to suffer for a short time. Two types of inquiries are used: hard inquiries and soft inquiries. Hard inquiries occur when you give lenders permission to view your credit history. Too many of these can hurt your short term credit score. Soft inquiries, for example checking your own score, have no affect on credit scores.
The final 10% is based upon why kinds of credit you have. It can be beneficial to have several different types of credit, such as revolving credit lines and installment loans.
Credit scores are used to compare the credit worthiness of consumers to others with similar circumstances. Each of the "Big Three" credit bureaus offer an unique credit score, but they are all modeled after the Fair Issac system of scoring. Experian uses the Experian/Fair Issac RISK system, TransUnion utilizes the FICO Risk Score System, and Equifax makes use of the BEACON system. Some lenders do use their own custom scoring systems and these often include additional factors such as yearly income and employment history.
Just how important is my credit score, and how will it affect my interest rates? What else is influenced by credit scores?
Credit scores will often have a direct correlation to the interest rate consumers are charged. The end result is that it influences how much you pay every month for your car loan or home mortgage. A poor credit score can lead to paying several thousand dollars more over the course of a loan than someone with a lower score. As your credit score goes lower you are seen as a higher risk. This will cause the lender to charge a higher interest rate to help mitigate some of their risk, thus increasing your total monthly payments. The inverse is also true; the higher your credit score is, the lower your interest rate and monthly payment will be.
Keep in mind that while your credit score has a great impact, other considerations also influence the interest rate charged for loans. Examples include what exactly you are using the loan to purchase, the amount of initial equity that you are providing, and how much you are borrowing.
Banks and other lenders are not the only businesses that make use of credit scores. Landlords, merchants, insurance companies, and even employers are interested in it as well. It is a controversial subject as to why an insurance company would base premiums on someone's credit score. It is hard to believe that driving history and credit scores would have a high correlation, but insurers believe that credit scores can be useful in determining how likely to file a claim someone is. Their point of view is that the lower a persons credit score is, the more likely they are to file a claim. Insurers do not use the scoring system that creditors use though, their system is unique and is referred to as an insurance score.
Using credit history as a basis for determining insurance rates is being scrutinized closely. In many states laws are being enacted that limit this practice. Some states prohibit insurers from making decisions based solely on credit history. Other states are requiring that if an insurance company decides to change a policy in a way that negatively effects a customer, the customer must be informed as to the reason for the change.
Another controversial practice that is upsetting to consumers is credit card policies concerning universal default. While your credit score helps to determine the interest rate you are charged, credit card rates can be changed at will. Even if you have always paid your bill on time for a specific card, defaulting on an unrelated loan can lead to the interest rates on that card increasing dramatically.
Hopefully you now see just how important credit scores really are. Checking your credit score, and looking for ways to make it better is a wise use of time and can save you great deal of money.