What is a Credit Score?

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What is a Credit Score?

It is a numerical index which represents an estimate of an individual's financial creditworthiness. It is based on a subset of the information in an individual's credit report. Lenders, such as banks and credit card companies, use credit scores to determine credit limits and interest rates. The use of credit or identity scoring prior to authorizing access or granting credit is an implementation of a trusted system.
The best-known credit score in the United States is the FICO score calculated using mathematical formulae developed by the Fair Isaac Corporation. The three major American credit reporting agencies (Equifax, Experian and Trans Union) all use variations on this scoring formula under different names, the best-known of which are the Beacon score and the Emperica score.

FICO scores and its variants are designed to measure the risk of default, by taking into account various weighted factors:

* 35% punctuality of payment in the past
* 30% capacity used, i.e., ratio of current revolving debt (e.g. credit card balances) to total available revolving credit (e.g. credit limits)
* 15% length of credit history
* 10% types of credit used (installment, revolving)
* 10% amount of credit obtained in the recent past

The above percentages are approximate. Current income and employment history do not influence the FICO score.

There are other special factors which can weigh on the FICO score. One is that any monies owed because of a court judgement, tax lien, or similar carry an extra negative penalty, especially when recent. Having above a certain number of consumer finance company credit accounts also carries a negative weight (critics say that this causes a vicious cycle, locking people into continuing to use consumer finance companies). The number of recent credti checks also can weigh down the score, although the credit agencies allow for credt checks made within a certain window of time to not aggregate, so as to allow the consumer to shop around.
FICO scores range from about 300 to 850 and exhibit a left-skewed distribution with a median around 725. A score above 720 is considered to be "good credit," and a score below 600 is considered to be poor.

In September 2004, a Texas utility company began setting individualized electricity prices based on credit score.

As a result of the FACT Act (Fair and Accurate Credit Transactions Act), free reports will be phased in during a nine-month period, rolling from the West Coast to the East beginning December 1, 2004. By September 1, 2005, free reports will be accessible to all Americans, regardless of where they live.

Recently, some of the agencies which generate credit scores have also been generating insurance scores, which insurance companies then use to rate the quality of potential customers.

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Ways to improve credit score

Since the method used to calculate the credit is essentially just an extremely complicated formula, one can change the scroe by causing changes in the variables that are important factors in the equation. Some ways of doing this are:
* Paying bills on time, since any payments more than 30 days late will affect the credit score. Note that a bill issued March 15 with a due date of March 31 does not become 30 days late until April 30.

* Paying the higher payment if a crunch makes it necessary to choose between paying two bills. For example, if an $800 house payment and a $300 car payment are due, and the person can only lay hands on $800, it will work out better for their credit score if they pay the house payment.

* Never declaring bankruptcy, since it can affect credit scores for more than a decade, depending on state law. Anything is better for one's scroe than bankruptcy – even working with a credit counseling service to get everything paid down.

* Trying to maintain 3-5 credit lines, since one's score will be lower if he doesn't have any credit.
* Trying to get rent and utility payments factored into one's creditscore as nontraditional credit if the person otherwise has no established credit.
* Attempting to stay within 10-30% of the maximum on each creditline, and not go over 50% on any in any event. Although this contradicts the advice many companies give when trying to get new customers to transfer balances, it will lead to a higher score than consolidating everything into one credit line and max it out. Try to convert revolving debt to installment 45 days (or more) before making a big purchase like a home or auto.
* Becoming an authorized signatory on one or more of one's parents' credit cards that they carry a balance on. If the parents pay it responsibly, the authorized signatory's creditscore will benefit, whether he personally charges anything to the card or not. This tip is especially useful for young adults with little or no established credit.
* Keeping an eye on how student loans are reported. Student loans are notorious for being reported multiple times, making it look like one's monthly payment obligations are higher than they actually are.
* Avoiding causing too many inquiries to be made right before applying for a big loan that depends on creditscore. One's scoring is affected by recent inquiries made by anyone other than the individual, their insurance companies, and certain others specified by law. When a person applies for new credti, for instance, and the creditor checks the credit report, that can cause a temporary dip in their score.