A Guide To Understanding Credit Reports and Scores

Chances are you have a pretty good idea about where you fall in the various risk categories seen by lenders. Whether you've bought a car, a house, applied for a credit card, or a myriad of other things; your credit history has been a key part of the process. If like many others, you fell into some unfortunate circumstances or were just irresponsible with your credit, you will find your life far more difficult than it needs to be. If your credit is that bad, then you probably don't have the ability to buy a house with cash.

Whether you've got good, bad, or great credit, you will find it difficult to manage unless you know how the credit reporting process works. Fortunately you don't need to be good at math or know any complex accounting equations. On the contrary, understanding your credit report and how credit scores work is fairly simple and straightforward.

Back in the 1980's, the three main credit agencies (Equifax, Experian and Transunion) worked with the Fair Isaac Corporation to develop the FICO method of scoring credit. When you hear people talking about credit scores, they are usually referring to their FICO score. This score will range from 300 being the highest risk credit score, to a perfect score of 850. The actual algorithms for what determines your score is kept secret, although the general formula is pretty well known.

• Payment History- This is the most important aspect of your credit, and accounts for 35% of your score. Now this includes paying bills late (If that particular payee reports), being sent to collections, and filing bankruptcy. The people living in this country with their own houses and high credit scores will usually tell you one simple rule: pay your bills on time. Everything else will follow suit.
• Outstanding Debt- All of your loans, credit cards, and mortgages fall under this category and make up 30% of your credit score. When lenders look at your credit, they generally will look at your debt to income ratio. Your FICO however, has no idea what your income is. For this reason, it simply looks at how much you owe total, as well as how close your credit cards are to the maximum limit. Having a card maxed out when the statement is prepared will instantly drop your credit score by several points.
• Credit History- 15% of your overall score is determined by how long you have had credit. Having multiple established credit lines will continually push your score up year after year.
• New Credit- Opening up new credit accounts will generally knock your score down a little bit for a short time, and this accounts for 10% of your score. This section also covers what are called "hard inquiries" sometimes referred to as "hard pulls". Every time you submit an application for credit, you get a hard pull. Having several hard pulls in a short amount of time drops your score, since it looks like you are scrambling for credit. However, having several inquiries of the same type (except for credit cards) in a 30 day period will all count as one hard pull. This allows people to "shop around" for the best loan rates.
• Credit Lines- Your various lines of credit will determine the final 10% of your score. The FICO system likes to see at least 2 major credit cards, as well as different types of credit, such as installment loans and mortgages. More variety shows that you can be responsible in all aspects of the credit world.

Now, before I go any further, I should mention that the FICO is not the only credit score out there. Each of the 3 major credit bureaus have their own scoring system as well. Typically when you go to a free credit report site and get a score, it's not your FICO but it's the score given by whichever agency owns that website. While they're all based on the FICO system, they are still different, and you can expect your score to be different as well. Some people have reported their FICO being higher than what is called a "FAKO" in many online forums, whereas others find their FAKO to be higher. In the end, it doesn't matter which score you use. If you're trying to build up your credit they're all going to be similar, and when one score goes up, they all go up.