Do You Know How Does Credit Scoring Works?

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Do You Know How Does Credit Scoring Works?

Credit scoring was an industry mystery for many years as financial institutions kept this information to themselves. However, since the Fair Credit Reporting Act, you're entitled to one free credit report from "Annual Credit Report" each year, which helps demystify the process with credit scores explained.

Now, you can see who reported you for missed or late payments, if your credit score was checked and by whom, and the rest of your financial profile. When all is said and done, there will be a three-digit number that will quickly let lenders know how risky you are as a borrower and will affect your access to lines of credit.

If you are to take away one lesson about improving your credit scores range, it's this: late or missed payments are bad, very bad. Payment history accounts for 35% of your credit score and includes everything from mortgage or rent to utilities, cell phone bills, credit cards, store charge cards, medical bills, auto loans, college tuition bills and student loans. If you are 30 days late on one payment, then it's not likely to cause severe damage to your report. It's only listed when you are "currently 30 days late" and even then, you can usually negotiate with your lender to cut you some slack since you're normally a good borrower.

If you're often 30 days late, then you may have a hard time convincing anyone to give you a favor. Once you're sixty days late, your credit score will be slightly damaged, but when you hit more than 90 days you'll have a tarnished score, which could be something like 100 points deducted for up to 7 years!

After 120 days, it's likely you'll have a charge-off on your record or an account that slips into collections. Short-term collection accounts will hurt you 50-75 points, although financial advisers at the Gallant Group say that older accounts won't hurt you as much, as these are just "a blip on the radar screen," they said. However, if you're applying for a new loan, then you may occasionally be required to go back and resolve any past due items on your report before being approved.

In credit scoring terms, 30% of your total number is derived from the outstanding debt you have, your credit limits and how much you've borrowed of the total extended to you. If you have an auto loan or a mortgage and you are paying the full amount every month on-time, then this will contribute to good credit scores.

Look at your credit card limits. If you have charged up 40% of the total amount without paying it off right away, then your credit score will drop 10 or 20 points. Anything over 40% will result in exponential drops, which could be as much as 100 points. If you have multiple, maxed-out credit cards, then rest assured you that your score will be off by at least 80 points.

Some people are obsessed with credit inquiries and fear that anyone checking their credit scoring will diminish their good standing. What many people don't know is that it's ok to shop around. Say you are looking for auto loans and get quotes from 3 or 4 different places over a period of 14 days: that will only count as one inquiry's worth of points and will only cost you 5 or 10 points for the next 30 days.

The reason inquiries cost you any points is that, statistically, people with six inquiries or more on their credit reports are eight times more likely to declare bankruptcy than people with no inquiries. You won't lose any points using credit report services as much as you like, though. Just be conscientious about applying for a bunch of new credit cards all at once.

About the Author

Mike Selvon's portal will expand your knowledge on credit scoring. Visit us and leave a comment at our credit score factors blog where a free gift awaits you.

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