18 Apr

What’s the Score?

April 18, 2012

No, I’m not talking about a game – unless you think of credit scores as a game. Which, now that I think about it, might indeed be the case. Like any game, there is a list of rules, and it might be wise to become familiar with these rules because they are pertinent to your financial life.

Your FICO score (the most common credit score used) can help a lender evaluate the risks of extending credit or loaning money to people. Five factors are weighed to calculate your FICO score:

1. Payment history 35%
2. Amounts owed 30%
3. Length of credit history 15%
4. New credit and recently opened accounts 10%
5. Types of credit in use 10%

 

If you notice, younger people may be at somewhat of a disadvantage because 15% of their scores are weighed by length. Every new credit account a person opens can also detract from the overall score. Think about it: a younger person tries to establish credit by opening new credit, but the newness and short credit history length both put a sizeable anchor on his or her efforts.

FICO credit scores range from a low of 300 to a high of 850 (less than 1% of consumers ever make it to a credit score of 850). Generally, a credit score of 720 or higher is considered “very good.” What does this mean to a consumer? Suppose you have a “very good” credit score and you borrow $300,000 for a 30-year mortgage. You “qualify” for a 3.8% rate. Now take someone with a not-so-good (under 720) FICO score. They might be offered 5.39% on the same $300,000 loan. If you do the math on this scenario, you’d see the not-so-good FICO score paying an extra $285/month or $102,600 extra over the life of the loan.

The point of this conversation is to be an informed consumer. Keep track of where you are with your score, rationalize what it can “cost” you, and think about how to stay at the top of the score board.

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