How Credit Scores are Calculated
Learn how the Credit Bureaus Figure Credit Ratings
Aug 17, 2009 Armand Famiglietti
When it comes to securing a loan for a car, home, boat, college education or any other large ticket item that must be purchased, a person’s credit score becomes front and center as to whether they will get the loan and at what interest rate. However, trying to understand how a credit score is calculated is like trying to understand the theory of relativity using only a slide rule. Here are some guide posts on how credit scores are calculated.
The Credit Score Range
The three credit bureaus rate a person’s credit between 300 and 850. 850 being on the pristine end of the equation, while 300 being on the poor credit side. While the paradigm of lending money will always get “looser” or “tighter” aiming for a score above 700 is ideal to secure loans for homes, cars, college educations and more.
How the Credit Score is Calculated
According to Money Magazine, the three credit bureaus figure the score in five major areas. How timely payments have been made accounts for 35 percent, how much is owed compared with the overall line of credit extended makes up 30 percent, the length of credit history is 15 percent, and whether one has recently taken out a new credit line and the mix of credit types one has (car, mortgage, credit card) make up the final 10 percent each.
Get to the Bottom of Things
The first thing that should be obtained is the credit score from all three bureaus. Each of the bureaus scores a bit differently, and so the number will vary slightly, though it should be fairly close. A large discrepancy indicates an inaccuracy.
Scour for Credit Report Mistakes
Look for places where a negative item is appearing on the credit report that should not be there. Sometimes honest mistakes are made, or sometimes a creditor has placed a negative item on the report that one may dispute. Either way investigate each negative item and dispute all inaccuracies. Disputing is a process by which one writes a letter to each credit bureau (in accordance with their guidelines.)
The credit bureau then checks with the creditor to see of a mistake was made. If so, the negative item will be removed. It should also be noted that each state has a statute of limitations as to how long a negative item may appear on a credit report. This range is from 3 to 11 years. If that timeline has expired since the last delinquency, then the item must be removed. Investigate the protocols in the applicable states.
Never Miss a Payment
It might be hard during times of economic strife, but it is better to pay the minimum for six straight months, then it is to make a large payment one month and miss a payment the following month. Budget all payments for home, car, credit card and collegiate loans for six months to ensure that the minimum will be available for payment.
Keep the Percentage of Debt Low
This applies to credit cards and credit lines (as opposed to mortgages and college loans). Keep the percentage of total debt between 20 percent and 30 percent. This means if a person’s credit line is $50,000, they should carry no more than $15,000 of debt in those areas. And it is also better to have that debt spread among several cards, rather than having one card maxed at $15,000 and other cards empty.
Longevity is a Friend
Keep the oldest credit card accounts in play. The bureaus like to see a nice long credit history. Also, the closing of an account will reduce the overall credit line, which will raise the percentage of debt.
A Few Factors Might be out of One’s Control
The mix of debt that the bureaus wishes people have is quite vague and can constantly change with the economic climate. Accept that there are few factors that just won’t ever be pinned down with the credit bureaus.
Keep Reading
Read The Credit Card Action Plan and More of the Credit Card Action Plan for additional information on how to pay down debts.
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