The lowdown on credit scores

November 4, 2005

The impact your credit score has on your life can be tremendous. Here's what to do to make sure your score is as high as possible.

Unlike your golf score, there's a very important number in your life that you want to bump up. It's your credit score. A marker for creditworthiness, your score will, to a great extent, determine the interest rate on your mortgage, car loan, and home equity lines. Your credit record can affect the amount of your insurance premiums, and even possibly your eligibility for certain cell phone plans.

A credit score is also commonly referred to as a "FICO" score, named for the Minneapolis-based Fair Isaac Corporation that developed the risk-assessment formula, and it ranges from 300 to 850. The median is 723, according to myFICO, a division of Fair Isaac. Aside from 100 points, what separates a "650" from a "750?" The credit score categories can generally be broken down like so:

Moving up or down a category on the scale can be measured in dollars and cents-lots of them. Look at the following example: With a score of 615, your interest rate on a $250,000, 30-year fixed rate mortgage would have been 8.53 percent recently, with a $1,928 monthly payment. If that score were 720, however, you could have gotten a 5.94 percent interest rate and seen your monthly payments drop to $1,430. Over the life of the loan, you would have saved $157,699 in interest.

Just how do the powers that be calculate a credit score? Knowing what factors go into the formula will help you understand what you're doing wrong-or right-and how to do better. Here are the criteria Fair Isaac uses in its FICO scoring evaluation, broken down by how heavily each factor is weighted:

On-time payment record (35%). Promptness is key, since it's likely that those who've been delinquent in the past are more apt to be so in the future. Delinquencies are the single most frequent negative score factor, according to the Experian National Score Index. And a single misstep can take its toll. "One late mortgage payment could make your score plunge 100 points," says Gerri Detweiler, founder of Ultimate Credit Solutions, a credit education company. "That's enough to move you down into a higher-risk category."

Outstanding debt (30%). There are about half a dozen measurements that fall under this heading. Aside from the total amount of debt and the number of accounts that have balances, another key component of your score is the ratio of your debt (or balance owed) to your credit limit. On a credit card, for example, prospective lenders want to see that your debt is no greater than 50 percent of your credit limit. Unfortunately, more than 16 percent of consumers have reached or pushed past the halfway mark, according to the Experian National Score Index.

Here's how much that can hurt you: The simulator on my FICO.com shows that, if your score is 707 and you just maxed out your credit cards, you could drop by anywhere from 20 to 70 points. Conversely, if you paid down 90 to 100 percent of your credit card balances over the next 24 months, your score could go up 50 or 70 points.

Length of credit history (15%). The older your accounts and credit lines, the better. Longtime payers who've shown they can master their finances and be responsible for numerous accounts make good lending prospects.