Those Pesky Numbers

In the last post we touched upon your credit score; mostly we talked about what credit was. Today we will go a little deeper into what your score is and what those pesky numbers mean and how they are created. 

Your credit score tells the people you want to borrow money from, how much of a risk you are to them and if you are good for it.  Meaning,  will you pay them back and do so on time? One could conclude that the better the score, the lower the risk and the lower the score, the greater the risk.  However, that is not always the case, but we will get to that later.

So, what does your score do for you?  Think back to school when a higher score on an assignment meant a better grade. That is the same principle here.  The higher your score the better your chances of getting credit and better options along with it.  On the flip side, the lower your score, the harder your chances of getting credit and the worse the options will be if and when you get it. Simply put:

• Higher score -> easier chances -> better options
• Lower score -> harder chances -> worse options

 That's all well and good, but what makes up your score?  It is common knowledge you have more than one score.  I'm sure you knew about the biggest three reporting agencies and their scores (and the fact they don't agree) but did you know you actually have up to 49 of them?!  Yes, 49.  Each and every iteration of your score is used for various services.  However, there is one common thing in all of them - the way the score is calculated.  (At least they all agree on the math!)

There are 5 categories/criteria that make up your score.  They are:

• Payment History - 35% of total score
• Debt Burden - 30% of total score
• Length of History - 15% of total score
• Types of Credit - 10 % of total score
• Recent Credit Searches - 10 % of total score

1) History - the most important of all the categories - this percentage is based solely on the payments you have already made. It is influenced by your ability to make a payment on time.  Every late payment (30 days or more) hurts you more than every on-time payment helps you.  Think of this as a one step forward, two steps back kind of thing. In addition to this, the length of your tardiness, say 60 or 90 days (and more) hurts you increasingly more. The biggest impact here will come from accounts that have been sent to collections, been charged-off, turned over to a lawsuit, been paid via wage garnishment, put on lien/judgment.  Your history, in the case of finances, will always catch up with you.

2) Debt - this percentage is based on the amount of debt you have available versus how much you still owe on it. All accounts factor into this and each account is looked at differently. Why? Because the types of loans (accounts) you have open are used as a signal to how well you manage your existing debt. This can be summed up with the phrase, credit utilization.  While it may seem wise to get rid of or have more of one type of account, the fact is a mix is necessary.  Examples of different accounts include - mortgage, auto, credit cards, and installment loans.

3) Length - this percentage is factored on how long you have been using credit.  First, how old is your oldest account, and second what is the average age of all your accounts.  Getting a lot of new credit in a short period of time can lower the overall average which can bring down the weight of this category on your score.

4) New Credit - this percentage is based upon how many new opened accounts and how many newly applied for accounts you have. This is really important because several newly opened accounts could be an indication of cash flow problems or that the borrower is planning on taking on a lot of new debt.

5) Types of Credit - this percentage is based on the types of and totals of each of your accounts. Since this category isn't a huge factor in your overall score, do not run out and open more accounts just to obtain a mix!

Next post we will break down your score and how it can help/hurt you and just what that looks like each month. 

Let me know your thoughts in the comments section below.