Basis for Rating Credit Scores

Credit scores are numbers used by various businesses to determine the creditworthiness of a person, and how much of a risk that person is in paying back a loan or credit. There are three major credit bureaus -- Experian, Equifax and TransUnion -- that collect financial information on individuals and then analyze, calculate and provide credit score numbers.

Importance of a Good Credit Score

• Having a high credit score is vital. When applying for credit such as a mortgage, home equity loan or auto loan, your credit score can determine whether or not you are approved. If you are approved, your credit score can also affect the interest rate you are charged. A high credit score often results in getting a low interest rate, as you are considered a low risk regarding repayment of the loan. Even if you are not seeking a loan, credit scores can come into play when you apply for car insurance. A high number may get you a lower rate.

Credit Score Computation Factors

• There are a variety of factors used in analyzing and calculating a person's credit score. A major part of the formula is based on your history of paying bills on time. Late payments are a negative factor and will lower a credit score. Outstanding debts impact a credit score, as does a bankruptcy. Other information used in the analysis includes the number of credit cards you hold and the amount of available credit on them, the length of your credit history used in the report, the amount of debt you owe and the types of credit you use. Having low debt and significant available credit on your credit cards are positive points in determining your credit score.

Credit Score Models

• There are different algorithms used to compute credit scores, but the most widely used is the FICO score, from the Fair Isaac Corporation, which, in 1958, originated the first system to create a credit score, and in 1978 was the first company to create a credit card score formula. However, even this formula exists in various forms. Equifax's version is called the BEACON score; Experian's is the Experian/FICO Risk Model; and TransUnion uses the EMPIRICA score. Each version will arrive at a slightly different score value, due to the different formulas and also because the same data may not be included in each company's statistical analysis. Generally, the credit score numbering system is a scale from 300 to 850, with most people having a score between 600 and 800. Scores of 720 and up are considered favorable.

How to Improve Your Score

• It takes time to raise your credit score, but begin by creating a history of paying all bills on time, including utility bills, monthly credit cards, mortgage and other loan payments. Obtain a credit report from each of the three major credit bureaus and check for accuracy. Clear up any discrepancies. Keep credit card balances low, and work toward paying down all debt.

Read the Fine Print

• The number of credit cards you have, the amount of available credit on them and your history of making on-time credit card payments are important factors in computing your credit score. You must properly manage your credit card accounts. Read the fine print before you apply for special offers from credit card companies when you get them in the mail. Some offer low-rate promotions, but after a short period of time, the rate may increase significantly. Compare rates and all the details of any credit card offer before accepting.