How Credit Scoring Works
In 2001, something new happened in the world of credit reporting, consumers were finally allowed to access their credit scores through various services. Before that, credit scores were used by lenders and creditors only. Now that the consumer has the ability to access his or her credit report, it is imperative that he or she has a good understanding of how Credit Scoring systems work, or how they are formed.
A credit score is somewhat of a beacon to potential lenders or creditors. The score, and what it is based upon, alerts potential lenders to whether or not a consumer would be a good financial risk, or would be likely to pay back the debt that is owed.
Credit Scoring models are often based on the following FICO principles:
#1: Payment history Payment history includes if you have paid your bills, and how promptly you have paid your bills. Thirty five percent of your credit score depends on this history. If you have negative payment history, the more recent it is, the more harmful it will be. #2: Outstanding debt FICO Credit Scoring attributes thirty percent of a consumer's score to how much debt he or she actually has. Having credit card accounts that are at or near their limits has a negative impact on one's score. The rule of thumb to follow is to maintain your credit accounts at a level of twenty five percent or less of the limit. #3: Length of credit history: How long a consumer has held his or her accounts also has a bearing on his or her credit score. Length accounts for 15 percent of the overall score. The longer you have held accounts, the more accurate picture a potential creditor can obtain on your credit habits. #4: New credit: Multiple inquiries to your credit, within a short amount of time, can affect a consumer's credit adversely. This accounts for 10 percent of the overall score. Hard inquiries, or those the consumer has given a creditor or lender permission to perform, are the most harmful to the score. The impact on the score is not permanent, however. A consumer also need not worry about soft inquiries, such as checking his or her own credit report. Soft inquiries have no effect on the score. #5: Types of credit held: The types of credit that are held by a consumer account for 10 percent of the score. Lenders like to see that a consumer has had experience with different types of credit, such as installment loans and revolving credit card accounts. It is certainly positive that Credit Scoring and credit reports are no longer strictly for those who have internal access to such information such as lenders and creditors. With information about his or her credit report within easy access, a consumer can be more aware of the score and what to do to maintain or improve it.
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