Credit scores are statistical calculations used to determine a person's creditworthiness. The most common credit score is the FICO score, named after software developer Fair Isaac and Corporation. FICO scores are typically provided to lenders by the three major credit reporting agencies -- Experian, TransUnion and Equifax -- to help lenders assess their risk in loaning money to individuals.
A person's credit score, which may differ by reporting agency, affects both his and her ability to qualify for different types of credit and to receive favorable interest rates. Based on national averages in December 2010, a homeowner applying for a $200,000, 30-year fixed mortgage with a credit score between 760 and 850, for example, may receive a 4.353% APR, resulting in monthly payments of $996. The same loan for a person with a lower credit score between 620 and 639 would result in a 5.942% APR, or $1,192 per month. Over the life of the loan, the person with the higher credit score would save approximately $70,000 in interest. While many people strive to achieve the highest credit score possible, few will earn that elusive perfect score -- the 850.
Keeping Score
Credit scores range from 300 to 850. According to MyFICO.com, approximately 13% of FICO credit scores exceed 800, and only 1% of consumers achieve a perfect score of 850. In general, the higher the score, the lower the risk to any potential lenders.
Five factors are included and weighted in calculating a person's credit score:
1. 35 percent -- Payment history
2. 30 percent -- Credit utilization
3. 15 percent -- Length of credit history
4. 10 percent -- New credit
5. 10 percent -- Types of credit used
The One Percent
While many people have excellent credit scores, what are 1% of Americans doing differently than the other 99%? Since a perfect score is so difficult to earn, those who do achieve it are often actively and consciously trying to do so. Whether you are gunning for a spot in the top or simply trying to improve your credit rating score, these tips can help.
• Pay bills on time -- Even one late payment can hugely impact a person's credit score. Paying every bill on time -- from credit cards, mortgages and medical bills -- is important to maintaining or achieving a high score. A perfect credit score will typically show no late payments in the last seven years.
• Use only a fraction of your available credit -- In general, the less credit you are using, the better. The ideal number to aim for is to use only 10-20% or less of your available credit each month. Thirty-percent of your credit score is based on credit use -- the ratio of your debt to your credit limit. The higher the number, the lower the credit score. People with perfect scores usually have a low utilization rate of less than 10%.
• Review your credit report -- Looking at your own credit report will not negatively impact your credit score. Consumers are entitled to at least one free credit report each year from one of the three major credit bureaus, and should review the report for any errors such as incorrect credit limits or delinquencies.
• Manage your credit card quiver -- Too many credit cards can make you appear desperate for credit. As such, it is better to have only a few credit cards, with the bulk of spending placed on one card since you can be penalized for having multiple large balances. Many issuers now automatically close inactive credit cards, so be sure to make small charges every few months on the lesser-used card(s) to keep the account open; otherwise, request that the account be closed.
• Diversify your credit -- Having multiple types of credit is a plus when it comes to your credit score. A consumer who has a variety of debt types may be considered financially responsible (assuming the payments are being made on time). Credit cards, mortgages, automobile loans and retail accounts can increase your credit score -- to a point. Too many accounts may reduce your score. A good number to aim for is six: this is the number of accounts that perfect credit holders typically have.
• Wait for it -- It takes time to build credit and to get a perfect credit score. Ten years of positive account history is generally needed to score above 800; people with a perfect score opened their first account 20 years earlier.
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