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Austin Real Estate Brokers How Credit Scores Work

Your credit score is a number generated by a mathematical formula based on information in your credit report, compared to information on tens of millions of other people. The resulting number is a highly accurate prediction of how likely you are to pay your bills.

If it sounds arcane and unimportant, you couldn't be more wrong. Credit scores are used extensively, and if you've gotten a mortgage, a car loan, a credit card, or auto insurance, the rate you received was directly related to your credit score. The higher the number, the better you look to lenders. People with the highest scores get the lowest interest rates.

Powerful little number

If you rented an apartment, got braces, bought cell phone service, applied for a job that involved handling a lot of money, or needed to get utilities connected, there's a good chance your score was pulled. If you have an existing credit card, the issuer is likely to look at your credit score to decide whether to increase your credit line or charge you a higher interest rate.

Buying a car? Most car dealers want to know your credit score when you walk in the door. They want to know how they can put a loan together for you. The score has made it easier for many people to get credit. Before, it was up to individual lending institutions to come up with their own criteria. They would hedge their risk and tend to go conservatively. It's opened up lending to a lot more people.

Consumers' rights

Until recently, many Americans didn't even know this number existed because it was a closely guarded secret in the lending industry. In fact, lenders were prohibited from telling borrowers their credit score. This changed recently though when consumers began finding out about the score and demanding to see it. In an unprecedented move in 2000, online lender E-Loan offered to give consumers their scores for free, with information explaining how the score is calculated and how they might improve it.

Public outcry on the possibility of people being denied credit based on bad information in credit reports led to several pieces of legislation and a much more open attitude about credit scores. Fast forward to current day: not only can consumers buy their score online from any number of sources, but they are now entitled to one free credit report per year.

Key factors of your score

Just what goes into the score? The model looks at more than 20 factors in five categories.

1. How you pay your bills (35 percent of the score)
The most important factor is how you've paid your bills in the past, placing the most emphasis on recent activity. Paying all your bills on time is good. Paying them late on a consistent basis is bad. Having accounts that were sent to collections is worse. Declaring bankruptcy is worst.

2. Amount of money you owe and the amount of available credit (30 percent)
The second most important area is your outstanding debt -- how much money you owe on credit cards, car loans, mortgages, home equity lines, etc. Also considered is the total amount of credit you have available. If you have 10 credit cards that each have $10,000 credit limits, that's $100,000 of available credit. Statistically, people who have a lot of credit available tend to use it, which makes them a less attractive credit risk.

Carrying a lot of debt doesn't necessarily mean you'll have a lower credit score. It doesn't hurt as much as carrying close to the maximum. People who consistently max out their balances are perceived as riskier. People who never use their credit don't have a track history. People with the highest scores use credit sparingly and keep their balances low.

3. Length of credit history (15 percent)
The third factor is the length of your credit history. The longer you've had credit, particularly if it's with the same credit issuers, the more points you get.

4. Mix of credit (10 percent)
The best scores will have a mix of both revolving credit, such as credit cards, and installment credit, such as mortgages and car loans. Statistically, consumers with a richer variety of experiences are better credit risks. They know how to handle money.

5. New credit applications (10 percent)
The final category is your interest in new credit -- how many credit applications you're filling out. The model compensates for people who are rate shopping for the best mortgage or car loan rates. The only time shopping really hurts your score is when you have previous recent credit stumbles, such as late payments or bills sent to collections.

The scoring model doesn't look at:
• age
• race
• job
• income
• education
• marital status
• if you've been turned down for credit
• length of time at your current address
• whether you own a home or rent
• time on job

A lender may consider all these factors when deciding whether to approve a loan application, but they aren't part of how a FICO score is calculated.

Credit scores are not perfect

The major drawback to credit scoring is that it relies on information in your credit report, which is quite likely to contain errors. That's why it's critical that you check your credit reports annually or at the very least three to six months before planning to buy a house or a car. This will give you sufficient time to correct any errors before a lender pulls your score.

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