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What Is Credit Score - Credit Score - Protect Your Finances and Your Identity

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The ongoing economic crisis has prompted many people to explore their financial status in more detail than in previous years. Frequently, consumers come up against the term “credit score,” but they do not really know what it means. However, this seemingly arbitrary number is crucial to getting the lowest interest rates and saving hundreds or even thousands of dollars over the term of a loan. For instance, a person with a low credit score may pay up to seventy-two thousand dollars extra over the length of a thirty year home loan.

Sometimes there is confusion over exactly what a credit score is. A credit score is not the same as a credit report. A credit report is a detailed account of a person’s past credit history, and it includes things like missed payments, bankruptcies, accounts that are over limit, and the amount of debt currently owed. A credit score is a number generated by mathematical statistical analysis to determine a person’s creditworthiness based on the information included in the credit report. There are three main credit bureaus in the United States that generate the majority of credit reports: Equifax, Experian, and TransUnion.

Typically, a credit score is a number between 300 and 800 and is based on a algorithm developed by Bill Fair and Earl Isaac in 1958. This method is now known commonly as a FICO score and is generally considered the best method of determining creditworthiness. Most people tend to fall in the 650-750 range, and applicants with scores below 620 considered high-risk. At one time, all three of the major credit bureaus used the FICO score as their algorithm. Recently, they have started using alternative methods as well, such as Equifax’s ScorePower and Experian’s PLUS score. They also all three offer the VantageScore algorithm, which produces a number between 501 and 990.

Credit scores usually take five factors into account. The most important factor is payment history such as the number of late payments or bankruptcies, and the second most important is the ratio of the amount of current debt to amount of available credit. These factors each count about a third of a credit score. The rest of the score comes from length of credit history (15%), the number of new accounts (10%), and several other minor considerations.

Banks use credit scores to determine when an applicant is an appropriate risk for a loan. In most cases, the lower a credit score an applicant has, the higher the interest for the loan will be. For instance, a person with a score of 720 may get an interest rate four points lower than a person with credit score of 530. Similarly, credit card companies decide interest rates and account limits primarily by evaluating credit scores. Even landlords will often require a credit check to insure that a potential renter is a good risk or how large a deposit may be required.

While a low credit score can lead to higher interest rates or even the possibility of being denied a loan, it is important to note that credit scores change over time. If an applicant has a low score at one time, the score can gradually go up as they continue to develop a more positive financial history. For instance, paying off outstanding loans and paying all bills on time can raise a credit score significantly year to year or even month to month.

In 2003, Congress passed the Fair and Accurate Credit Transactions Act, which gives consumers the right to get a free copy of their credit report and credit scores from all three bureaus once a year. Additionally, there are several third-party services that offer real-time monitoring of an individual’s credit report for a small fee. This has the added benefit of helping to protect oneself from identity theft. Most identity crimes manifest first in credit applications and are initially detected by monitoring unauthorized changes to a credit report.

Knowing your credit score can be a good first step to protect your identity as well as to give you financial peace of mind. At the minimum, credit scores should be examined annually to ensure that any mistakes are corrected immediately.

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