It is important to know how a credit score is calculated if you want to maintain a perfect score. But first of all, do you know what a credit rating is? Why would you want to have the highest score possible? The answers to these questions may seem obvious but you will soon find out how complex this may be.
What is a credit rating? It also goes under the name of FICO score, which is the credit scoring model of Fair Isaac Corporation that established the credit rating most used worldwide. This is a number that is based on your credit history and represents to creditors your likelihood of paying a loan on time.
What does this FICO score really mean? This score is considered to be an index of risk. It indicates the level of risk involved for a creditor when conceding a loan and determines the rate at which the creditor will lend you the money. In other words, if your credit rating is high, you will be conceded the loan at a low interest rate. On the other hand, if your credit rating is low, you might not get the loan or if you do get it, it will be at a very high interest rate.
So, how is this FICO score calculated? A percentage of the score is given to different criteria. It may be broken down to 5 different factors that are taken into consideration for tallying this score.
1. Past Payment History (35%)
The greatest percentage is allotted to how well you have paid your debts in the past, taking into consideration any late payments.
2. Current Debts (30%)
The second largest percentage is based on how much you owe at the present time. It is usually calculated as a ratio of what you owe divided by how much available credit you have. In general, to keep a good score, you should maintain this ration under 35%. In other words, for every thousand dollars of allotted credit, you should only owe $350. Don’t get me wrong, I’m not saying your credit rating will decrease as soon as you get a loan. I only want to bring to your attention that it is not a good idea to have many small disperse loans. This tends to portray you as someone that might not be able to pay its debts, consequently lowering your credit rating.
3. Duration of Credit History (15%)
In third place comes how long you have had a credit history. The older your history the higher your rating. This makes sense, just as you can better judge someone’s personality by how long you know that person, the same goes with a credit institution. If you have a long history, they can tell if you are overall a good paying customer. Thus, be able to judge if you manage your finances well.
4. New Credit Accounts (10%)
Every time you inquire about applying for a loan, just keep in mind that this can lower your credit rating. Creditors will not see with a good eye if, in a period of one year, you start opening accounts with various institutions.
5. Credit Diversity (10%)
On the other hand, credit diversity is beneficial to your credit rating. If you can manage several different kinds of loan, this will give you some extra points. For instance, you can be paying off your car, mortgage or some other loan.
So, now you know what a credit rating is and how to maintain a good standing, but do you know how this translates in numbers? A FICO score extends from as low as 300 to as high as 900 points. Here is the breakdown.
Excellent Credit – 720 and above
Good Credit - 660 to 719
Fair Credit - 620 to 659
Poor Credit – 619 and less
Where do you stand? If you don’t know what your credit rating is, you can get a copy from a financial institution. However, be prepared to pay for this service. It is recommended that you do some research to find out which credit bureaus charge the least.
Okay, so you have a low credit score, but is this the end of your financial power? Definitely not! What this simply means is that you will have a harder time in obtaining a loan and when you do, it will be at a very high interest rate.