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Paragon Blog

The 5 Factors of Credit Scoring: What is a credit score and how does it work?

Memphis, TN - November 23, 2015

Introduction

The subject of credit scoring has become an increasingly hot topic, and for good reason. For many years, the general public only associated the concept of credit scoring with the need to purchase high-ticket items such as a new car or a home. Today, credit scoring goes much further. Your credit score can affect your ability to get a good rate on commodities such as car insurance, cell phones, or even determine whether or not you get the job or promotion that you want and deserve. Indeed, the financial snapshot provided by the credit score has also become a gauge for many employers, especially those who seek to place employees in a position of management or financial responsibility.

Why Your Credit Score is So Important

The credit scoring model seeks to quantify the likelihood of a consumer to pay off debt without being more than 90 days late at any time in the future. Credit scores have many different ranges, however, the score that is used by 90% of lenders and creditors in this country is the FICO score, and the FICO score range is 300 to 850. The higher the score, the better it is for the consumer, because a high credit score translates into a low interest rate. This can save literally thousands of dollars in financing fees over the life of the loan.

 

The Five Factors of Credit Scoring

Credit scores are comprised of five factors. Points are awarded for each component, and a high score is most favorable. The factors are listed below in order of importance.

1.     Payment History – 35% Impact

Paying debt on time and in full has the greatest positive impact on your credit score. Late payments, judgments and charge-offs all have a negative impact. Delinquencies that have occurred in the last two years carry more weight than older items.

2.     Outstanding Credit Card Balances – 30% Impact

This factor marks the ratio between the outstanding balance and available credit. Ideally, the consumer should make an effort to keep balances as close to zero as possible and definitely below 30% of the available credit limit at least 2-3 months prior to trying to purchase a home.

3.     Credit History – 15% Impact

This portion of the credit score indicates the length of time since a particular credit line was established. A seasoned borrower will always be stronger in this area.

4.     Type of Credit – 10% Impact

A mix of auto loans, credit cards, and mortgages is more positive than a concentration of debt from credit cards only. You should always have 1-2 open major credit card accounts.

5.     Inquiries – 10% Impact

This percentage of the credit score quantifies the number of inquiries made on a consumer’s credit within a twelve-month period. Each hard inquiry can cost from three to fifteen points on a credit score, depending on the amount of points someone has left in this factor. Note that if you pull your credit report yourself, it will have no effect on your score.

Remember that the credit score is a computerized calculation. Personal factors are not taken into consideration when a credit report is generated. It is merely a snapshot of today’s credit profile for any given borrower, and it can fluctuate dramatically within the course of a week.

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