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Credit Scores

Your credit score is a number generated by a mathematical algorithm -- a formula -- based on information in your credit report, compared to information on tens of millions of other people. The resulting number is a highly accurate prediction of how likely you are to pay your bills.

If you've gotten a mortgage, a car loan, a credit card or auto insurance, the rate you received was directly related to your credit score. The higher the number, the better you look to lenders. People with the highest scores get the lowest interest rates.

The FICO score scale runs from 300 to 850. The vast majority of people will have scores between 600 and 800. A score of 720 or higher will get you the most favorable interest rates on a mortgage.

1. How you pay your bills (35 percent of the score)

The most important factor is how you've paid your bills in the past, placing the most emphasis on recent activity. Paying all your bills on time - good. Paying them late on a consistent basis - bad; having accounts that were sent to collections - worse; declaring bankruptcy - worst.

2. Amount of money you owe and the amount of available credit (30 percent)

The second most important area is your outstanding debt -- how much money you owe on credit cards, car loans, mortgages, home equity lines, etc. Also considered is the total amount of credit you have available. If you have 10 credit cards that each have $10,000 credit limits, that's $100,000 of available credit. Statistically, people who have a lot of credit available tend to use it, which makes them a less attractive credit risk.

3. Length of credit history (15 percent)

The third factor is the length of your credit history. The longer you've had credit -- particularly if it's with the same credit issuers -- the more points you get.

4. Mix of credit (10 percent)

The best scores will have a mix of both revolving credit, such as credit cards, and installment credit, such as mortgages and car loans. Statistically, consumers with a richer variety of experiences are better credit risks.

5. New credit applications (10 percent)

The final category is your interest in new credit -- how many credit applications you're filling out. The only time shopping really hurts your score, is when you have previous recent credit stumbles, such as late payments or bills sent to collections. At that point, looking for new credit will be seen as an alarm because statistically, before people declare bankruptcy or default on debts, they use up any available credit.

What doesn't count in a score. The scoring model doesn't look at:

  • age
  • race
  • sex
  • job or length of employment at your job
  • income
  • education
  • marital status
  • whether you've been turned down for credit
  • length of time at your current address
  • whether you own a home or rent
  • information not contained in your credit report

A lender may consider all those factors when deciding whether to approve a loan application, but they aren't part of how a FICO score is calculated.

Credit scores are not perfect

The major drawback to credit scoring is that it relies on information in your credit report, which is quite likely to contain errors. That's why it's critical that you check your credit reports annually, or at the very least three to six months before planning to buy a house or a car. That will give you sufficient time to correct any errors before a lender pulls your score.

© Dawn Smith