Your credit score uses information from your financial history to predict how likely you are to default on your future loan payments. When you apply for credit, such as a credit card or loan, one of the first criteria lenders look at will be your credit score. The most widely used credit score is the FICO score, which is calculated using an algorithm developed by the Fair Isaac Corp. The Fair Isaac Corp. licenses this algorithm to the credit bureaus that then calculate your credit score.
Score Range
Your FICO credit score has a range from 300 to 850. The higher your score, the less likely you are to default on your future loan payments, which makes you a more appealing borrower to lenders. According to the Kiplinger website, the median credit score is 723 and only 13 percent of borrowers have credit scores that exceed 800.
Misconceptions
Your credit score may differ between the three major credit bureaus--Experian, Equifax and TransUnion--even though they all use the same formula for calculating the score. This is because each bureau may have information about your credit history that the others do not. For example, if one of your credit cards only reports your account activity to Experian and you have missed several payments, your Experian score may be lower than your other scores.
Significance
Your credit score, while not the only factor, is very important in determining if you get credit and, if so, how much interest you will pay on the loan. According to Bankrate.com, lenders typically offer their lowest interest rates to people who have credit scores over 760. If your credit score drops below 620, you will likely be considered a subprime borrower and be offered higher interest rates. Bankrate also states that a score below 500 will most likely not qualify for a mortgage at all.
Considerations
Your credit score takes into consideration five factors, with each factor being weighted differently. Whether or not you've paid as agreed in the past, including defaults and delinquencies, accounts for 35 percent of your score. The amount you currently owe and the amount of credit that you have available to you counts for another 30 percent of your score. Fifteen percent of your score comes from how long you've had credit. The remaining 20 percent of your score is split evenly between the variety of credit types that you've made use of and the amount of credit you've applied for within the past two years.
Effects
A small change in your interest rate can result in significant additional costs or savings depending on the size of the loan. The larger the loan, the more significant the change. For example, according to the Fair Isaac loan savings calculator, if you took out a 30-year, $250,000 mortgage with a credit score of 690, you would pay an annual percentage rate of about 5.142 percent. If your credit score increased to more than 760, you would save almost $22,000 over the life of the loan. However, if your credit score dropped to 650, you could see the total cost of the loan increase by over $36,000. However, these calculations are based solely on your credit score. The interest rate you actually pay will also take into consideration other factors such as your employment history and debt-to-income ratios.
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