Since the housing bubble burst, people are more concerned about their credit score than ever. Higher scores are better, and the Internet is filled with advice for how to improve the number ever closer to 850. It’s unusual for people to ask about the credit score’s origin and more importantly, how its components are calculated. Here’s a brief explanation.
When people talk about their “credit score,” they’re referring to their “FICO score.” FICO scores are proprietary information created by the Minneapolis, Minnesota-based company, FICO (Fair Isaac Corporation). Contrary to intuition, the company’s name is based on the name of its founders, Bill Fair and Earl Isaac, so the “Fair” has nothing to do with fairness. FICO scores range from 300 to 850, but they don’t fall on a bell curve with 575 as the media; rather, the curve skews towards 300, so few people have very high credit scores while more people have low credit scores.
Although FICO’s formula is a closely guarded trade secret, people do know some things about the score’s compositions:
(1) Payment history (35 percent): Late payments reduce credit scores; on-time payments maintain and improve them.
(2) Credit capacity used (30 percent): FICO essentially divides people’s revolving debt (credit cards) by their total available credit (the borrowing limit on a credit card). The lower the ratio, the higher the credit score. Because credit capacity used is a ratio, decreasing the numerator (the amount of credit) or increasing the denominator (total available credit) both improve one’s credit score. Oddly, closing an account will lower a person’s credit score.
(3) Length of credit history (15 percent): having credit for a longer period of time will increase one’s credit score.
(4) Types of credit (10 percent): Paying down a few different types of loans, whether they’re credit cards, mortgages, student loans, cars, etc., can increase the credit score.
(5) Past credit applications or searches (10 percent): FICO considers multiple inquiries about a person’s credit worthiness over a short period as detrimental to his or her score. This is more true for credit card applications than auto loan or mortgage applications. Employer searches and individuals checking their own credit will not reduce their scores.
Knowing the components of a FICO score can help people understand why they have low credit and what measures they can take to improve it. Those who have excessive credit card debt should not worry about their credit score as much as their financial bottom line. In those circumstances, filing a Chapter 7 bankruptcy might be a good idea.
For more questions about bankruptcy in Las Vegas, please feel free to contact an experienced Haines & Krieger Las Vegas bankruptcy attorney for a free initial consultation. Call us at -800-LAWYERS to set up a free consultation.