Your Dumbed-Down Credit Score

What exactly does your banker see in you? You can find out instantly by ordering your credit report online. You'll receive a rundown of your banking record and an overall GPA -- a credit score based on your history of handling money.

You'll be amazed at the amount of detailed credit information at your fingertips. Too bad it's not what your banker uses to base his lending decisions.

FICO (and other credit scoring companies) offers different risk models to banks, insurers, and even landlords than it does to the general populace. Think of it as over-the-counter vs. prescription-strength versions of its product. There can be 20 or more points' difference between what you see on your screen and the report in your mortgage broker's inbox. At current rates, that could be the difference between qualifying for a 8% car loan or having to settle for a 10% one.

It might seem unfair, but consider that a credit score is really just a measure of how likely you are to repay a loan. The industry rightly assumes that you -- the consumer -- are not in the banking business. So your credit score is based on more general risk-assessment measures. Corporate clients, however, put their money on the line and use a more exacting measure of a potential client's likelihood of taking off to Tahiti with the bank's dough.

Still, that doesn't mean that the score is useless to you. In many cases the corporate and consumer numbers are completely in sync. While you have no control over the algorithm that your score is based on, you're very much in charge of everything else in your credit file. And it's this information that your mortgage broker, your car insurer, your potential employer, and anyone else interested in measuring your worth is plugging into its black box.

Even general guidelines about how a score is calculated are useful. Based on information directly from FICO, here's what matters most to those judging you:

1. Past payment history. Your payment punctuality weighs heavily (about 35%) on your credit score. The more recent your tardiness, the more points you sacrifice. Your credit report will indicate whether you are 30, 60, or 90 days or more late with a payment. A history of late payments on several accounts will cause more damage than late payments on a single account. On the flip side, by paying your bills consistently on time, you can greatly improve your overall score.

2. Amounts owed. Add up all of your outstanding balances and compare the number to the amount of credit that is available to you. If you are reaching -- or exceeding -- your credit limits (perhaps you've heard the term "maxing out"?), lenders will get antsy. This measure of your credit karma makes up 30% of your credit score. At the same time, if you aren't anywhere near maxing out your accounts, you want to make sure that the credit extended to you isn't out of proportion with your income. Interestingly enough, your score can be significantly affected depending on where you are in your billing cycle. You can add 20 points to your score the day after you pay your credit card bill (even if you pay in full every month).

3. Length of credit history. Fifteen percent of your credit score is determined by how long you've been using credit. Obviously, the longer your credit history, the more favorably lenders will see you. Your score in this area also takes into account how long it has been since you used certain accounts. So just having an idle card for 10 years won't necessarily raise your score. Don't open a lot of new accounts at once to establish a credit history. That strategy will lower the "average account age" on your score, which could affect your score negatively.

4. Amount of new credit. Each time you apply for new credit, an inquiry shows up on your report. Red flags start waving when you take on more credit -- or even just apply for new credit -- in a short period of time. This is one area where good habits can work against you. If you prove yourself a reliable bill payer, charge card issuers will be quick to offer additional credit.

Future lenders, however, may not take kindly to all this readily available credit. Some fear you will use it to go on a spending binge, quickly undermining standard calculations for determining how much additional debt you can shoulder. This area of credit management carries a 10% weight on your overall credit score.

When you shop for new credit (such as a home loan), try to do so in a concentrated period of time. FICO distinguishes a search for a single loan and requests for many new credit lines. (Note that requesting a copy of your own credit report -- even through our sponsor's limited-time 3-report/3-score deal -- does not affect your score.)

If you've had trouble with this area in the past, you can boost your score by re-establishing credit (not too much credit, though!) and making on-time payments.

5. Types of credit. Types of credit include credit cards, retail accounts, and installment loans (such as car loans and mortgages). Your use -- or overuse -- of these has a 10% impact on your overall score. Though you may be tempted to show what a good borrower you are by using all types of credit, more is not always better in the eyes of credit scorers. If you have had no credit, lenders will consider you a higher risk than someone who has managed credit cards responsibly.

A little curious about your credit rap sheet? TrueCredit -- the consumer arm of TransUnion -- has extended Fool readers a limited-time special offer. Receive a $10 discount on its 3-Report/3-Score package, which includes data from the three major credit bureaus (TransUnion, Equifax, and Experian) as well as credit scores (your GPA of borrowing) from all three entities. Fools pay just $34.95.


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