When a lender is about to loan you money, they want to know what is the chance of you paying that money back. Hence the FICO score. Now to be fair, there are different scoring systems out there, each with their own methods for calculation.
The Score
The score ranges from 300 (very bad risk) to 850 (very good risk). The lower your score, the more the system thinks you’re likely to not be able to repay the loan. Where a high score says they believe there is a high chance of you repaying the loan.
The average score varies from year to year, but right now it is estimated to be just under 700.
Typically, the younger you are, the lower your score will be, we’ll talk about why in a little bit. In your twenties you’ll see a score of about 660 and in your thirties, it will be 670 to 680 on average.
However, you can have a high score and be in your late 20s and 30s. I know, I had a 735 at 25, and ~750 at 30.
A good score doesn’t just help you with getting a good interest rate. It can also help you get a good (car) insurance rate, and some jobs will use it to determine how (financially) stable you are, especially if you are going to be working with money.
What makes up the score
Now the actual way it’s calculated is a bit of a mystery, and it is updated from time to time. However, we can give you a basis.
Payment History
Want to kill your credit score – miss paying a bill, or two. The longer it is late the worse the effect will be. Miss a couple, and you can quickly tank your score.
This is the number one contributing factor to your score. Up to 30% for most scoring companies.
Amount Owed
The amount owed, as a percentage of the amount you can borrow, is the second highest scoring factor.
The system can’t tell that you went on vacation, put everything on the card and will pay it off next month, so it drops your score. When you pay it off next month, your score will go back up.
The thought is, if you can borrow $100,000, and you are, then it will be difficult to pay that all back. It might even signal that you are getting ready to “run” instead of paying.
Run can mean physically leaving town, or something like declaring bankruptcy, etc.
Typically this only/mostly looks at unsecured loans (credit cards) not your mortgage or car loan, although it may, just to a lesser extent.
Credit Age
The longer you’ve had open accounts, the better your score will be. Bad accounts tend to get closed, and new accounts, people may not know how to use them.
Your credit age, makes up a big part of your score and is part of the reason why younger people don’t have as good of a score. Opening a card in college helps get people’s credit established, but too many abuse it.
I got a credit card for emergencies, and then didn’t even keep it on me, so I wouldn’t be tempted to use it. It let me build up some history, without it costing much money.
New Credit
Get a new card, and it looks suspicious. Add a bunch of new debt, and the system asks why. Did you lose your job and need to buy food so you got a new card, but that means you’ll have a hard time paying it back…
If you are getting a lot of new inquires, it looks “suspicious”. So your score will drop. To protect you, typically only the first check will count against you. So if you got to three car dealerships and they each run your credit, you only get hit once.
Check on mortgage options, and get three or four quotes, only the first one affects you. The basic idea is that the average person won’t be buying multiple new cars or houses at one time.
However, each credit card inquiry into your account, will negatively effect you since you could get multiple cards at once.
Credit Mix
The different types of loans you have does matter. The more revolving lines of credit (credit cards, department store cards, etc) the worse for your score. These tend to be more risky.
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