Here's How Your Credit Score Gets Calculated
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Credit, credit, credit вЂ” we hear all the time how we need to have a good credit score. As the prime indicator of our financial trustworthiness, a clean credit report and high credit score tell lenders we are financially sound. While many consumers have their credit in order, roughly one-fourth (24.4 percent as of October 2012) of Americans have a FICO score of under 600, according to theВ FICO score distribution charts, rendering this portion of the population ineligible for most types of loans.
You need a score in at least the mid- to high-700s to receive good rates on home and auto loans, and to be eligible for some of the premium credit offers. However, the average U.S. consumer credit score ofВ under 690В shows that as a whole, we have mediocre credit. Is this a result of the recent recession? Maybe overspending? Perhaps these are all contributing factors.
FiveВ components of a FICO score
Your credit score is calculated using the five major parts: payment history, length of credit history, types of credit used, amounts owed, and new credit. Although many consumers have somewhat of an idea that these factors impact a credit score, when asked specific questions, the results were a bit surprising.
WhenВ WisePiggyВ asked if missing a payment can ding a credit score, only 69 percent of survey respondents answered correctly. On-time payments of course fall under the payment history category, which is 35 percent of your credit score.
What about your outstanding balances compared to your line of credit? Do they impact your score? Only 40 percent of survey respondents seemed to think that credit utilization, or how much of your available credit you have out, can raise or lower a credit score. Utilization goes under the amounts you owe portion (30 percent) of the credit calculation, and it absolutely has an impact on your score.
Only around 43 percent of survey respondents thought that opening a new credit card could ding a credit score, leaving around 57 percent who said it would not have any impact. In this case the majority is incorrect, as opening a new card or any new line of credit impacts the new credit (10 percent) portion of your score calculation. Hard inquiries for new credit can also take off a few points. These inquiries occur when various lenders request to pull your credit file to approve you for a Visa card here and a MasterCard there. Additionally, when you open a new credit account, it may potentially shorten the average length of all of your credit accounts, as well asВ impact yet another area of your score calculation: the length of your credit history (15 percent).
Around half (46.45 percent) of survey respondents thought the number of accounts they have opened could raise or lower their score. While the sheer number of accounts you have is not directly calculated in your score, this may have an indirect impact on your utilization, mix of credit, and payment history, so both responses could really be considered correct here.
While many of the survey respondents were fuzzy on exactly whatвЂ™s included in their credit reports, some of them were also unsure aboutВ the information that is excluded. For instance, around 31 percent of respondents believed checking your credit report can negatively impact your score. With all of the talk about inquiries and how it can hurt your score to have your credit pulled too much, itвЂ™s understandable that some respondents would think this. Because pulling your own file is viewed as a soft inquiry, however, it doesnвЂ™t hurt your score.
When you go to a lender and they talk about debt-to-income ratios, it may make you think that income has an impact on your credit score. ThatвЂ™s what around one-third of survey respondents thought. Although having a high income may help you pay your bills faster, it has zero direct impact on your credit score.
What about your banking habits? A small percentage of survey respondents thought their savings account balance (around 10 percent) or how much theyВ used their debit card (around 10 percent) could also raise or lower their credit score. Because these are not credit accounts, these generally have no impact on a credit score.
Read the original article on The Cheat Sheet. Copyright 2014. Follow The Cheat Sheet on Twitter.