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What are Credit Scores?

Credit Scores Range

A credit score is a numeric representation of the information on your credit reports. Credit scores predict consumer credit risk and credit behavior. They are almost always based wholly or partially on information in your credit reports.

Your credit score is a number that affects everything you do - it can affect your ability to get a job, rent an apartment, get a cell phone, and buy a car or home. It's incredibly important to not only be aware of your credit score, but to be on top of making sure it's correct and there are no inaccuracies. Smart Credit allows you to see your score, as well as specifics on the items that are negatively affecting it.

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Credit scores range from 300 on the low end to 850 on the high end (using the FICO scale). The higher the score the lower your credit risk. The lower the score the higher your credit risk.

Credit scores are usually built using consumer credit data from each of the three major credit reporting agencies; Equifax, Experian and TransUnion. Statistical analysis is conducted using current and historical credit data to determine what's predictive of future credit behavior. This is called "regression."

Many people believe only a score is delivered when calculated, which is not true. The score is accompanied with explanations of why you didn't receive the maximum score. These explanations are called Score Factors or Reason Code. They are the top four reasons, in order of importance, why your score isn't higher. These score factors can be used as a roadmap for how to improve your score.

The five major components of a credit score include the following:

  1. Current and historical payment history - Are you paying your bills on time? If not, how delinquent are you? If you are delinquent, how often are you delinquent? And finally, how long ago were you delinquent?
  2. Amounts you owe - How much debt do you have? What type of debt is it? Are you maxed out on your credit cards? How many accounts do you have with a balance?
  3. Length of time had credit - What's the oldest account on your credit report? What's the average age of your credit accounts?
  4. New credit - How many new accounts have you recently opened? How many inquiries do you have in the past 12 months?
  5. Mix of credit used - Do you have a diverse set of accounts on your credit reports? Or, are you just using credit cards?

Credit grantors use credit scores to approve mortgages, auto loans, and credit cards. There is no single universal score required by lenders to approve or deny any application. Each credit grantor selects their own credit score threshold based on their experience and risk appetite.

The score is used to make "approve or deny" decisions, set interest rates, determine what products to offer (premium cards versus subprime cards). Those with the highest scores get the best interest rates, which saves them an enormous amount of money.

For example, let's take a car financed at $25,000 over 48 months using credit scores to set the rate. With a credit score of 750 you'll likely get an interest rate of 4.8% (the best interest rate), which means your monthly payment will be $573. With a credit score of 650 you'll likely get an interest rate of 11.7%, which means your monthly payment will be $655. The "lower score" payment is $82 more per month for the same exact car. The total interest paid with the lower score is $6,440 compared to only $3,936 with the higher.

The best way to earn a high score is to pay your bills on time, pay your bills in full, don't use more than 10% of your credit limit on credit cards, don't open new accounts unnecessarily, and don't close older accounts.

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