Credit scoring 101

Don't worry, Credit Scoring 101 doesn't require any prerequisite courses, but you'll want to be ready to learn about a few tricky algorithms and number crunching. Learn how your credit reports and scores are evaluated. Grab your #2 pencil and let's get started!

History
The credit scoring system became prevalent during the 1980's as a way for lenders to quickly evaluate a potential borrower's creditworthiness. The system was found to accurately predict financial risk over time and grew to several different industries. Credit scoring is used by lenders to evaluate your credit behavior.

Algebra
Thousands of different credit scoring formulas exist today for various evaluation purposes. Each unique credit scoring system is accurate and correct for its own application. The credit scores you can order online use an algorithm created for consumers that approximates these different formulas. Your online credit scores may vary a bit from the score your lender uses, but they should be in the same range.

Chemistry
The basic credit scoring formula takes into account several factors from your credit reports. The impact of each element fluctuates based your own credit profile:

• Payment history – A good record of on-time payments will help your credit.


• Outstanding debt – High balances in relation to your credit limits can harm your credit. Aim for balances under 35%.


• Credit account history – An established credit history makes you a less risky borrower. Think twice before closing old accounts before a loan application.


• Recent inquiries – When a lender or business checks your credit, it causes a hard inquiry and a slight ding to your credit score. Apply for new credit in moderation.


• Types of credit – A healthy credit profile has a balanced mix of credit accounts and loans.

Economics
When you are preparing for a major purchase make sure you check your credit scores and credit reports from all three credit reporting agencies: TransUnion, Equifax and Experian. Looking at your scores and reports a few months before your loan application will help you get a complete picture of your credit health. Worried if your credit score makes the grade? If your credit score is above 700 you will probably qualify for a prefferedloan. Under 650, you may have trouble receiving new credit.

If your credit score is a little low, pay your bills on time, reduce your debt, remove inaccuracies and avoid new inquiries for a few months. Plus, don't forget that your credit score is not the only factor a lender may look at when they are evaluating your financial standing.