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Understanding your Credit Score:
Importance, Calculation and Improvement
Banks, credit card companies, and other lenders base their credit decisions on
several factors – among them your experience with borrowing and repaying, your
income, job history, etc. Most people recognize these items as questions a credit
application typically ask. The lender uses this kind of information to assess the
relative risk of being repaid on time.
Why Your Credit Score is Important
The higher your credit score,
the lower your payments!
$30,000 new car loan, 60-month term
Interest rates as of October 1, 2013:
Many people are not familiar with how their experience with borrowing and
repaying is processed into an overall rating score, how important that score is in
getting a loan approved, and in many cases how the score can affect the interest
rate on that loan. As an example, this table shows the significant effect your credit
score can have on loan pricing – generically called risk-based pricing.
FICO®
Score
Interest
Monthly
Rate (APR) Payment
Total
Interest
Paid
720-850
3.45%
$545
$2,705
690-719
4.845%
$564
$3,841
Also, remember this: Your auto and home insurance, as well as other insurance
can be impacted by your credit score. Depending on your credit score, the
premiums you pay may be decreased (higher score) or increased (lower score).
660-689
6.967%
$594
$5,614
620-659
10.866%
$650
$9,016
590-619
15.421%
$720
$13,221
500-589
16.981%
$745
$14,716
The table (at right) shows a 60-month car loan using average rates from lenders.
As you can see, the difference between a weak score (generally below 620) and
an excellent score (generally above 720) is a much better rate and shows reduced
monthly payments.
Rates: Informa Research Services
Chart: myfico.com
How It’s Calculated
The pie chart shows the components of the most widely used credit score calculation, the FICO® score, developed by Fair Isaac
Corporation®. The score serves as a quick and objective summary of your credit history. The information that goes into your score
calculation is provided by past lenders based on your history with them, so
you may want to periodically review your credit report to confirm the accuracy
Credit Score Components
of information it contains. By federal regulation, each of the major credit
reporting agencies, Equifax®, Experian®, and TransUnion®, are required to
provide a free copy of your credit report upon request on an annual basis.
Types of
Credit
in Use
Payment
History
10%
How to Improve Your Score
New
Credit
10%
35%
Length of
Credit History
Amount
Owed
15%
30%
Note that in the pie chart, the largest component is payment history.
Consistently paying what is due, on time, is the most important thing you can
do to improve your score. The second largest component is amount owed.
The combination of having a reasonable amount of debt (not maxed out on
credit cards!) and paying on time are the most effective ways to boost your
score.
For More Information
More information about credit scores and managing your credit can be found
at www.myfico.com. Information about obtaining a free copy of your credit
report can be found at www.annualcreditreport.com.
Chart courtesy of myfico.com. Percentages based on importance
of category for the general population. In some cases the
weighting may be different.
(301) 688-7912 or (800) 826-1126 or (301) 688-7912
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