About Credit Cards and FICO Scores
The role of credit scores
Your application for a credit card is subject to a great deal of scrutiny by the issuer. Your reported income, total portfolio of savings and investments, status as a renter or a homeowner, and type of motor vehicle you own, lease or finance may be considered relevant factors. Yet one of the major factors determining the worthiness of your credit status is your credit score.
Actions that influence your credit score
In short, this is a summary of your outstanding financial obligations, payment history (even one single late car payment can seriously ding your score), and other factors. Your various financial transactions are tracked over time and compiled to create a "snapshot" of your risk to the institution from which you would like to borrow money. This could be an auto dealer, department store, or bank. It is also becoming more common for potential employers to seek these scores during the hiring process.
The most widely used credit scoring method is the one originally developed by the Fair Isaac Corporation (FICO) in the 1980s working in cooperation with the three major credit reporting bureaus. These are Equifax, Experian and TransUnion, and you may be familiar with their names if you have ever bought a car or a house or applied for a credit card.
Your personal credit score is calculated using a number of variables. Each variable in the equation has its own weight, which means some variables are more important than others. The scores range from 300 (truly awful) to 850 (good as gold). These scores play a crucial role in how much it will cost you to borrow money for any purchase that you wish to finance (e.g., motor vehicle, house, boat), as well as influencing your credit card interest rate.
Here are the relative weights of each of the five variables.
- Payment history (35 percent). Included in this category are bankruptcies, late payment of bills, and any unpaid bills, debts or other financial obligations that have been placed with collection agencies. Recent incidents are considered more serious than incidents that may have occurred years ago, and therefore have a disproportionate effect on this category.
- Outstanding current debt (30 percent). How much do you still owe on your card loan or your mortgage? How many credit cards do you have that are maxed out to their limit or are using more than 25 percent of your card's individual credit line?
- How long you have had credit (15 percent). Generally, the longer you have had established credit the better it is for your overall credit score. However, since your past payment history is often considered a reliable predictor of your future payment history, a spotty history is a negative.
- New credit and credit inquiries (10 percent). Anytime you open a new credit card account or obtain a loan from any source (e.g., a motor vehicle financing institution or a bank or credit union), your score will decline for a brief period of time.
- Types of credit (10 percent). This final variable encompasses all types of credit you have access to. This means bank issued Visa or MasterCards, department store or retail cards (e.g., Target, Kohl's, Macy's), and installment loans.
All of your information is measured against and compared with all other consumers who have similar credit histories and patterns. The three major credit reporting bureaus all use the basic FICO guidelines established in the 1980s, but have modified them over time to better meet their own needs.
Here is what the scores are and what they mean to your ability to obtain credit and how they influence the interest rate you might be offered.
- 760-850. Excellent. Should qualify for best interest rates.
- 700-769. Great. Should qualify for a good interest rate.
- 620-700. Good to fair. Should qualify for a less than good interest rate.
- 580-620. Poor. Should you qualify, the interest rate will be high.
- 300-579. Awful. Should you qualify, which is doubtful, expect a sky high rate.
You can improve your credit score over time by always making payments on time, refusing to take advantage of unsolicited credit card offers, never making overdue payments, and maintaining a debt level that is as low as possible.