Credit Score - FICO Ratings Explained
Improving Your Credit Score
A credit score is a number that represents the credit worthiness of an individual and the likelihood of that person paying his or her debts. Many people would like to improve their credit rating scores. Any person can get a credit report from the three major credit reporting agencies for free annually, plus they can get a copy of their FICO score, which does have a fee. FICO is an acronym for the term Fair Isaac Corporation Score. The NextGen 2.0 model is a change that credit reporting agencies are now using, which made some changes in the FICO scoring criteria.
With the drop in the credit rating of the United States, many economists are predicting credit card interest rates, as well as, fixed rates for new loans will all be increasing, so the wise person will eliminate debt as soon as possible.
FICO Standard Scores
Excellent - 750-840
Good - 660-749
Fair - 620-659
Poor - 340-619
The exact formulas for calculating credit scores are secret, however, FICO has disclosed some components:
- The payment history makes up 35% of the score; therefore, if you're late making payments on bills, such as a mortgage or credit card this can cause your FICO score to drop. Conversely paying your bills on time improves your score.
- Credit utilization comprises 30% of your score. They look at the ratio of current revolving debt (such as credit card balances) to the total available revolving debt or credit limit. In order to improve the FICO score, pay off revolving debt in order to lower the credit utilization ratio. In addition, applications for and receiving the credit limit increase can also drive down the utilization ratio. Closing existing revolving accounts will typically adversely affect the ratio, which will have a negative impact on your FICO credit score.
- The length of your credit history accounts for 15% of your credit score; therefore, as the credit history ages this will have a positive impact on your FICO credit rating.
- The type of credit used accounts for 10% of your score. Your score can benefit from managing different types of credit, (i.e. installment, revolving, consumer finance and mortgage).
Another 10% is based on recent searches for credit. Shopping for a mortgage or auto loan over a short period of time will probably not decrease your score as a result of these inquiries.
Numerous inquiries when a consumer is seeking new credit can hurt your scores, particularly with credit cards. All credit inquiries are recorded and displayed on your credit report for a period of time. However, an individual doing self-checks, an inquiry by an employer for employee verification or companies initiating pre-screened offers of credit or insurance do not impact your credit score.
There are a couple of other special circumstances that can negatively your FICO score. Money that is owed because of a court judgment or a tax lien does carry an additional negative penalty, particularly when recent. Having one or more newly opened consumer finance credit accounts may also have a negative impact.
Evaluate Credit Score
Finding Your Credit Rating
FICO scores are between 300 and 850, and 60% of the scores are right between 650 and 799 with the median score of 723.
The three major credit agencies utilize the score generated with their data differently:
- Experian: FICO Advanced Risk Score
- Equifax: Pinnacle
- TransUnion: Precision
Fair Isaac Company has developed a new method called 'NextGen FICO 2.0', which they say addresses important credit trends by improving score accuracy and maintaining predictive power. Theoretically these changes will benefit consumers and lenders by allowing easier scoring, updated treatment of inquiries and a more consumer friendly content; this method will be utilized by all three major credit agencies. The new model is similar to the FICO scoring but the range is between 150 and 950. The Fair Isaac Company estimates the new model will provide a 5 to 15% score list for non-prime consumers.
It has a more forgiving algorithm from the previous scoring model, as they acknowledge that savvy consumers shop around for the best rates when obtaining credit, therefore, there won’t be a negative impact when shopping for new credit that lowers your credit score. The younger population often suffers under FICO since they don't have a credit history, so they're not “scoreable”. The NextGen has lowered the minimum scoring criteria to be able to score a larger population, which will allow particularly young adults to be able to use their score and receive new credit. Under the old FICO guidelines it took six months to receive a credit score and now only one line will need to be open for three months to receive a score. These changes are minor but they will result in 2% of the population being able to receive a credit score.
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How to Raise Your Credit Score
Now that you are well aware of how a credit rating is determined, it is important to do the things necessary to improve your score. Get a copy of all three credit reports and your FICO credit score. This will clearly show you what you need to pay off first.
If you are paying on a collection account, there will be a negative impact on your score and this is the first thing you want to pay off. Of course, delinquent accounts are listed on your credit report in a column called "Past Due". If you see anything in this column on your credit report, pay them off absolutely as soon as possible.
Charge-offs and liens within the past 24 months will severely damage your credit so it's very important to pay these off also. However, if these are older than 24 months, it does not negatively impact your credit. Prioritize and pay your past due balances first, then pay your collection agencies when they agreed to remove all references to credit bureaus.
It is possible to request a good faith adjustment from your creditor with whom you have late payments that removes them from your credit report. Persistence pays off if they refuse to remove these late payments. Remind them that you had been at a good customer and would deeply appreciate their help. Most creditors receive calls at a call center, so if the representative you're speaking with refuses to make a courtesy adjustment, call back and try again with someone else as your persistence and politeness can often pay off.
Make sure your creditors report your credit limits to credit bureaus, because if no credit limit is reported the software used by the credit agencies often show your account has “maxed out.” As an example if you have a $10,000 credit card limit, which doesn't show on your credit report your score can be damaged as severely as if you are carrying this whole balance. Ideally, you want to keep money owed under 70% of your total credit limit at 50% is even better and 30% even better.
Generally do not close your credit cards, as this will hurt your credit score ratings. For example, if you have credit card debt of $15,000 and your total credit is $30,000, you are using 50% of your total credit. If you close a card with a $10,000 limit, you change your ratio to using 66% of your credit, which will hurt your credit score. If you have more than six department store credit cards, you can close the newest account but don't close the rest.
Keep your old credit cards current even if you're not using them anymore. Use them once or twice a year so the bank doesn't close them as this positively affects your long-term credit rating.
Establishing New Credit
If you don't have a credit card, you should get one to build your credit but if your credit is not adequate, try getting a secured card, which means giving a bank typically $500 for a VISA card. Then use the card each month and pay it off in full. It is not necessary to carry a balance. Another excellent way to improve your credit is to get an installment loan, which can consist of personal loans, automobile loans, mortgages and student loans. Be very careful when getting a loan that the payment is an amount that you can easily afford.
Bank secured credit cards can help you improve your credit score
Great Credit Can be Yours
I know many people are in bad shape financially and having to resort use of credit cards for groceries. The main thing is to at least make a payment every month. If you are in the position where you want to improve you credit score follow the steps outlined above. I hope you area a better understanding of the FICO rating system with the new changes. Your credit is something that you need to treasure because once you ruin your credit it is a long process to regain your credit score.
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The copyright to this article is owned by Pamela Oglesby. Permission to republish this article in print or online must be granted by the author in writing.