No Matter the Formula, Keep Credit Score High

By Kathy M. Kristof

March 19, 2006 12 AM PT

Times Staff Writer

The nation’s big credit reporting agencies announced last week that they were launching a standardized credit score -- with grades from A to F -- to make it easier for both lenders and consumers to understand the often misunderstood ratings.

The new VantageScore from Equifax Inc., Experian and TransUnion is intended as an alternative -- and competitor -- to the three-digit FICO score calculated by Fair Isaac Corp.

But whether your credit score is expressed as a number or a letter, the most important thing is knowing how to establish a high rating, and keep it high.

A good credit score makes it easier to get a loan, and can allow you to get credit at a lower cost. A top rating gives individuals access to the lowest-rate loans and the lowest fees, which can save thousands of dollars over time.

Fair Isaac, the nation’s leader in credit scoring estimates that there’s more than a 1.5% difference in mortgage rates for those at the top of the credit scale versus those near the middle. On a $200,000 mortgage, that difference costs a person with the lower score almost $200 a month -- more than $71,000 over the life of a 30-year loan.

How are credit scores calculated and what determines your score? Equifax, Experian and TransUnion declined to detail the alchemy that goes into VantageScore. It’s likely, however, to be similar to what goes into the FICO scores, which range from 350 to 850.

The formula for creating those scores works like this:

FICO first sorts each person into one of 10 credit categories so that, for instance, people with “thin files” -- not a lot of credit history -- are compared only against other people with thin files.

The formula then starts with a neutral score -- about 600 points -- and begins adding and subtracting points based on the activity shown in the file, said Craig Watts, a Fair Isaac spokesman.

Scores are based only on what is in the consumer’s credit file -- and that file can be different from one credit bureau to the next. So it’s not uncommon for the same person to find that his or her FICO score at TransUnion is different from that at Experian or Equifax. There are also some variations in the formula, based on which of the 10 categories a person falls into and which bureau is providing the report.

Nonetheless, five factors account for the vast majority of any FICO credit score.

* Thirty-five percent of your credit score is based on how you have repaid your credit obligations. Points are added for people who always pay their bills on time; points are subtracted for those with some late payments, non-payments, “restructured” payments -- when the creditor agrees to take less than what’s owed -- and bankruptcies. The more credit that you have used, and paid consistently, the better your score. Naturally, the most serious credit faux pas take away the most points -- a bankruptcy is going to harm your score much more than a few 30-day late payments.

* Thirty percent of a score is based on your debt-to-available-credit ratio. The lower that ratio, the higher your score.

For instance, if you have a $100,000 home equity line and four credit cards, each with $5,000 limits, your total available credit is $120,000. If you’ve borrowed a total of $5,000 on the credit cards and $10,000 on the home equity line, your debt amounts to $15,000, or 13% of your available credit.

If, however, you have just $20,000 in available credit and have borrowed $15,000, you have a 75% debt-to-available-credit ratio. That makes you look overextended and will result in a much lower credit score.

Moral of this story: Consolidating your debt onto one or two cards and canceling the unused cards could hurt your score by reducing the amount of credit you have available and, thus, boosting your ratio. Unless there’s a compelling reason to cancel -- such as having to pay annual fees to hold those unused cards -- don’t.

* Fifteen percent of your score is based on the amount of time you’ve managed credit. If your credit file lists experiences, from student loans to credit cards, that go back decades, you’ll score better than somebody whose oldest credit experience was what was reported last month.

* Ten percent of your score is based on how many different types of credit you have handled in the past. Someone who successfully paid a mortgage, a home equity loan, a car loan and credit cards will score higher than someone who has one type of loan.

The good news: Repaid debts usually remain on your file for many years, Watts said. So you don’t get penalized for responsible behavior such as paying off your car loan, he said.

* The final 10% of your score is based on new credit applications and consumer-initiated credit “queries.” Each time you apply for credit, a credit query hits your file. If you have a lot of those inquiries in a short period of time, this portion of your score suffers, Watts said. That’s because people who apply for vast amounts of credit in a short stretch are eight times as likely to file for bankruptcy, he said.

There are two caveats. Pre-approved offers that you might receive in the mail do not count as queries, unless you actually take them up on the offer and apply for credit.

Also, FICO discounts multiple queries for auto or home loans, for example, when they happen over a short stretch. Those types of inquiries usually mean the person is rate-shopping -- a responsible credit activity -- so they don’t count against you in the formula, Watts said.

Kathy M. Kristof, author of “Investing 101” and “Taming the Tuition Tiger,” welcomes your comments and suggestions but regrets that she cannot respond individually to letters or phone calls. Write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012, or e-mail kathy.kristof@latimes.com. For previous columns, visit latimes.com/kristof.

By the numbers

Few consumers get a perfect FICO score, and nearly half get under 700. Here’s a breakdown of the U.S. population and how the score is calculated.

-Percentage of U.S. consumers falling in a FICO score range-

Score of 800 to 850--13%

750 to 799--27%

700-749--18%

650-699--15%

600-649--12%

550-599--8%

500-549--5%

499 or less--2%

Weight of factors used in calculating a FICO score