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How is my Credit Score Calculated?

Hiker Standing At Edge Of RiverA very important piece of your overall financial health is your credit score. A credit score is a tool predicting how you will manage your debt in the future based on how you have managed your debt in the past. Lenders, insurers, employers, landlords and others all use credit scores to determine what services you qualify for and how much those services will cost.

Credit scores from the three major credit bureaus (Experian, Equifax and TransUnion) generally fall between 300 and 850. A score above 700 is considered fair or good and scores above 760 are considered excellent. Scores below 600 are typically charged higher loan rates, and if your credit score is lower than that, you may be not be able to open a savings or checking account or borrow at all. The higher your score, the less risk you represent.

Credit score is calculated considering these 5 basic items:

Payment history - 35%
Capacity - 30%
Length of credit - 15%
Accumulation of debt in the last 12-18 months - 10%
Credit Mix - 10%

Payment History – 35%

One common theme in understanding credit scoring is that time has healing power. The longer it has been since a negative incident occurred, the less it will affect your score. A late payment five years ago is going to have much less impact than a late payment last month. Additionally, the amount of a late payment has no impact on the score. Making consistent on-time payments monthly is extremely important to maintaining a strong credit score. Delinquencies will stay on your record for seven years.

Capacity – 30%

Capacity represents the ability a member has to borrow and it makes up 30% of a credit score. The lower the capacity, the lower your credit score. If you have $50,000 in limits on credit cards and your current balance on those credit cards is $49,000, your capacity is 2%. Alternatively, if you have $50,000 in limits on credit cards and your current balance is zero, your capacity is 100%. A low capacity demonstrates that you are using all the credit you have available and you could be a riskier borrower.

Length of Credit – 15%

Length of time you have had credit is important because if you have a credit score, but have only had credit for 6 months, there is not a proven ability to maintain that high score. It is extremely important for you to keep open the oldest account you have. Frequently members will close this account as it is often a small department store charge account. If your oldest account is closed, there can be a significant impact on your score.

Accumulation of Debt – 10%

Another important factor used in calculating a credit score is the accumulation of debt in recent (12-18) months. The more you have been "shopping" for credit, the lower your score may drop.

There are some important exceptions to this rule. The credit reporting agencies give you some leverage with both mortgage and auto purchases. If you have several similar mortgage or auto "inquiries" on your credit report within a few days or weeks, these do not have a significant negative impact. However, you have numerous credit card inquiries, the impact could be more significant.

Credit Mix – 10%

A credit “mix” is the different types of debt you might have. Installment or closed-end loans can raise a score. Installment loans include auto loans, mortgage loans, home equity loans or closed-end debt consolidation loans. Revolving loans can lower a score. Revolving loans include credit cards or other open-end lines of credit. In addition, the number of finance companies that appear on a member's credit report also lower the score.

There are several things that are assumed to have an impact on credit score, but do not. These are debit ratio, income, length of residence and length of employment. These items may go into making a lending decision, but does not affect credit score.

You can obtain a copy of your credit score from any of the major agencies including Experian, Equifax and TransUnion.