After the amount of savings and assets one has, a credit score is probably the most important number when it comes to personal finance. Having a high score allows for more financial freedom and can save a borrower thousands of dollars on the terms of a loan. The score ranges from 300 on the low end to a high score of 850.
The Daily Ticker recently interviewed Mark Greene, the Chief Executive of FICO - the company that creates the credit scores used by most financial institutions - and asked him just how is the score calculated and what can be done to maintain or raise it?
How is it calculated?
FICO score is calculated from 5 different financial ingredients based on your personal credit history. It's important to note, age, sex and race are not factors.
Here's the breakdown:
35% - Payment history. Put simply, "have you paid your bills onetime reliably over time?"
30% - Amount of credit available. "If you have a lot of credit available but not used, that's a good thing," says Greene. The lower the balance on your credit, the better.
15% - Length of credit history. The longer you can show you're a reliable risk, the better it is for your score.
10% - New credit. Don't open a lot of credit suddenly. "When we see many new credit instruments being opened in a small period of time - that's a concern," Says Greene.
10% - Type of credit used. It's helpful if you have different types of credit - a credit card, an auto loan, a mortgage etc.
The higher the score, the more money you save
The higher your FICO score the more money you can borrow and the better the terms of your loan. Here's an example:
On a $300,000 30-year mortgage a score of 760 versus 650 saves you $190 per month or nearly $69,000 over the life of that loan. On a $20,000 36-month auto loan raising your score from 650 to 760 saves $65 per month in interest or $2,300 over the life of that loan.
Pitfalls to avoid
Bankruptcy is obviously the worst thing you can do for your credit score. Someone with a credit score as high as 700 can see their score plummet more than 200 points from seven to ten years.
The next most detrimental thing for your score is a foreclosure or short sale. Keep this in mind if you're contemplating walking away from your mortgage. Your credit score could drop 100-200 points and for up to seven years.