When you left school, you probably figured that would be the end of grades, report cards, and disapproving comments scrawled in the margins of your term papers. What a cruel fate, then, to learn that another score follows you through adulthood.
That's your credit score, and poor marks can do more than get you grounded. They can cost you a lot of money.
Your credit score is the result of a statistical computation meant to tell lenders whether it's likely that you'll default on a loan. The higher the score, the more trustworthy you're deemed. This means your score will determine whether or not you can get a loan, and it will often determine the interest rate you're charged.
If your score's low, lenders will view you as a risky borrower. That means fewer will be willing to lend you money. Those who do will charge higher interest rates, costing you a lot extra over time.
What's a good credit score? Fair Isaac, which issues the nation's leading credit scores, marks individuals' credit worthiness with score of 300 to 850. They report that the national median FICO score sits at 723. Half of us score higher than that, and half of us score lower. You'll have three of these scores, one based on the information held by each of the three major credit reporting agencies.
Experian, one of those three agencies, also reports that the average American scores 673 in its version of a credit score, called the PLUS Score. That's based on a representative sample of 3 million consumers. Their scores can range from 330 to 830.
What goes into a credit score? It's not a random number picked by a faceless bureaucrat in a grey, concrete building (though many a borrower has often wondered whether that's the case). Fair Issac has released some information about what goes into its FICO score. Here are the major components, ranked in order of their importance.
The first and most important component of your credit score reflects your payment history -- whether you're timely or tardy paying your credit and debt accounts. That includes credit cards, retail accounts, installment loans, mortgages, etc. Any information about past due accounts, delinquent accounts, and debts sent to collection will be factored in here. Any bankruptcies, judgments, suits, liens, and other items show up here, too. On the positive side, this portion will reflect your good behavior when you're punctual. This factor accounts for 35% of your score.
Second, accounting for 30% of your score, is the total amount you owe to lenders. This portion compares the total amount of credit at your fingertips with the amount of debt you have outstanding. In other words, lenders want to know if you're maxing out all your available credit. This section will also reflect the amount still owed on your installment loans.
Three other items count for smaller proportions of your credit score. One, comprising 15% of your score, is the length of your credit history. In general, the longer you've proved good creditworthiness, the better. The score looks, too, at the length of time since there's been activity on each account.
Lastly, your new credit accounts and your types of credit accounts each comprise 10% of your score. Under new accounts, the score takes into consideration the number of recently opened accounts, recent inquiries, and your efforts to re-establish good credit if you've had payment problems in the past. The category examining types of credit looks at whether you hold credit cards, installment loans, a mortgage, or other types of accounts.
Dump all these factors in a big bowl with a pinch of salt, stir, and you'll get your credit score.
How do you find out your score? You'll have to pay for it. Although you're entitled to free copies of your credit reports each year, the reporting agencies do not have to divulge your score without getting a little cash from consumers.
If you find you're below average -- and definitely if you're heading toward the bottom end of the spectrum -- you've probably got some room for improvement. The next part of this series will look at how bad credit can cost you; and then we'll look at fixing your credit report to reap the benefits.
Browse through our Credit Center, where you can learn all about credit reports and how to care for your credit score. Or read these articles to find out why you should know your score, and how you can improve if you're getting a bad grade.
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Fool contributor Mary Dalrymple has gotten too old to remember her SAT scores anymore and does not own shares of any company mentioned. She welcomes your feedback. The Motley Fool has a disclosure policy.