by Gail Vaz-Oxlade, for Yahoo! Canada Finance
Thursday, May 27, 2010
Ever wonder how that magical number – The Credit Score – is computed?
Whether you’re obsessing over your FICO score or your Beacon score, you’re likely shopping for credit. The FICO score was developed by Fair Isaac & Co., which began credit scoring in the late 1950s. The point of the score is consolidate your credit profile into a single number. The Beacon score is a brand name used by Equifax, the largest credit-reporting agency in Canada. While Fair, Isaac & Co. and the credit bureaus do not reveal how these scores are computed, whether you get a loan or not is a numbers game: The more points you score on your credit app, the better you do.
There’s a reason you have to fill out so much information when you’re applying for credit. Everything counts. Your age, your address, and even your telephone number all have a role to play in whether or not you’ll get credit.
Young ‘uns and old folk are at a disadvantage since under 21 and over 65 likely means you aren’t working; no points for you. If you’re married, you’ll get a point for being “stable.” And while you might think that being divorced would work against you (all that spousal and child support), most creditors don’t give a whit.
No dependents? Zero points. You’re probably still gallivanting like a teenager since you haven’t yet “settled down.” One to three dependents? Score one point. You’re a solid citizen. More than three dependents? Score zero. Have you no self control! And don’t you know you that with all those mouths to feed you could get in debt over your head?
Your home address counts too. Live in a trailer park or with your parents? Bad risk, score zero points. You could skip town with nary a look over your shoulder. Rent an apartment? Give yourself one point. Own a home with a big fat mortgage and you’ll score major points since someone has already done some checking and you qualified for a mortgage. Own your home free and clear? Even better. You’ve proven you can pay off a sizable debt and now you have a pile of equity that the card company would love to help you spend.
Previous Residence? Zero to five years (some applications only go to three years), score zero points since you move around too much. No land-line: zero points. How the Dickens are they gonna find you when you fall behind in payments. Since they can’t use your cell phone to actually locate you physically, it doesn’t count.
Less then one year at your present employer earns you no points. Again, it’s a stability and earning continuity thing. The longer you’re on the job, the more likely you are to be bored out of your mind but you’ll score more points. And, not to overstate the obvious, the more you make the better.
The more willing you are to make your lender rich, the higher your score will be. Since the FICO score was originally designed to measure customer profitability, if you pay off your balance in full every month, you’re going to score lower than the guy who only makes the minimum payment and pays huge amounts of interest.
Scores range from 300 to 900 and if you manage to hit 750 or above you’ll qualify for the best rates and terms. Score 620 or lower and you’ll pay premium interest if you even qualify; 620 is the absolute minimum credit score for insured mortgages.
Your credit score can change quickly. Payment history accounts for about 35% of your credit score and just one negative report can drop your pristine score into the doldrums. Since scores are updated monthly, your bad behaviour won’t go unpunished for long.
The type of credit you have counts for about 10% of your score. And your current level of indebtedness accounts for about 30% so going too close to your credit limit is another way to deflate your score. One rule of thumb is to keep your balances below the 65% mark. So if you have a limit of $1,000, you won’t ever carry a balance that’s more than $650.
Having too much credit available can also hurt your ability to borrow since the more credit you have, the more trouble you can get yourself into. If you’ve got a walletful of cards, canceling credit you’re not using can be a good thing – for both you and your credit score – over the long haul. Careful though. If the card you’re eliminating is one with a long, positive history, you’ll eliminate what could be a very good record of your repayment when you cancel the card. You’d be better off cutting up the card so you aren’t tempted to use it, while you establish a track record (six months or more) before you actually cancel the account.
Credit shopping can also cost you points. Since about 10% of your credit score relates to the number and frequency of new credit enquiries, applying willy nilly for new credit will end up costing you. However, it’s only when a lender checks your score that this registers on your score. Checking your own credit report/score is considered a “soft” inquiry and does not go against your score.