Tip No. 1 – Understanding where your credit score comes from

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If you are going to improve your credit score, then logic has it that you must understand what your credit score is and how it works. Without this information, you won’t be able to effectively improve your score because you won’t understand how the things you do in daily life affect your score. If you don’t understand how your credit score works, you will also be at the mercy of any company that tries to tell you how you can improve your score – on their terms and at their price.

In general, your credit score is a number that lets lenders know how much of a credit risk you are. The credit score is a number, usually between 300 and 850, that lets lenders know how well you are paying off your debts and how much of a credit risk you are.

Generally, the higher your credit score, the better credit risk you are and the more likely you are to be given credit at lower interest rates than people with low credit scores. Scores in the low 600s and below will often have trouble obtaining credit, while scores of 720 and above will generally give you the best interest rates out there. However, credit scores are a lot like GPAs or SAT scores from college/university days – while they give others a quick snapshot of how you are doing, they are interpreted by people in different ways. Some lenders will put more emphasis on credit scores than others.

Some lenders will work with you if you have credit scores in the 600s, while others offer their best rates only to those peoples with high credit scores. Some lenders will look at your entire credit report while others will accept or reject your loan application based solely on your credit score. The credit score is based on your credit report, which contains a history of your past debts and repayments. Credit bureaus use computers and mathematical calculations to arrive at a credit score from the information contained in your credit report.

Each credit bureau (primarily in Canada – Equifax and Trans Union) uses different methods to do this (which is why you will have different scores with different companies) but most credit bureaus use the FICO system. FICO is an acronym for the credit score calculating software offered by Fair Isaac Corporation company. This is by far the most used software since the Fair Isaac Corporation developed the credit score model used by many in the financial industry and is still considered one of the leaders in the field.

In fact, credit scores are sometimes called FICO scores or FICO ratings, although it is important to understand that your score may be tabulated using different software. One other thing you may want to understand about the software and mathematics that goes into your credit score is the fact that the math used by the software is based on research and comparative mathematics. This is an important and simple concept that can help you understand how to boost your credit score. In simple terms, what this means is that your credit score is in a way calculated on the same principles as your insurance premiums.

Your insurance company likely asks you questions about your health, your lifestyle choices (such as whether you are a smoker) because these bits of information can tell the insurance company how much of a risk you are and how likely you are to make large claims later on. This is based on research used by actuaries. Studies have shown, for example, that smokers tend to be more prone to serious illnesses requiring more medical attention. If you are a smoker, you may face higher insurance premiums because of this. Similarly, credit bureaus and lenders often look at general patterns. For example, people with too many debts tend not to have great rates of repayment and your credit score may suffer if you have too many debts.

Understanding this can help you in two ways:

i) It will let you see that your credit score is not a personal reflection of how good or bad you are with money. Rather, it is a reflection of how well lenders and companies think you will repay your bills – based on information gathered from studying other people.

ii) It will let you see that if you want to improve your credit score, you need to work on becoming the sort of debtor that studies have shown tends to repay their bills. You do not have to work hard to reinvent yourself financially and you do not have to start making much more money. You just need to be a reliable borrower. This realization alone should help make credit repair far less stressful! Credit reports are put together by credit bureaus, which use information from client companies. It works like this: credit bureaus have clients – such as credit card companies and financial institutions, to name just two – who provide them with information.

Once a file is begun on you (i.e. once you open a bank account or have bills to pay) then information about you is stored by the credit bureaus. If you are late paying a bill, the clients contact the credit bureaus and recorded on your file. Any unpaid bills, overdue bills or other problems with credit count as dings on your credit report and affect
your score.

Information such as what type of debt you have, how much debt you have, how regular you pay your bills on time, and your credit accounts is information that is used to calculate your credit score. Your age, sex, and income do not count towards your credit score. The actual formula used by credit bureaus to calculate credit scores is a well-kept secret, but it is known that recent account activity, debts, length of credit, unpaid accounts, and types of credit are among the things that count the most in tabulating credit scores from a credit report.

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