A credit score is a number that lenders use to determine the risk of lending to a particular borrower. Credit card companies, car dealers, and mortgage bankers are three common examples of lenders who will check your credit score before deciding how much they are willing to lend you at an interest rate. Insurance companies, landlords and employers can also use their credit score to see how financially responsible they are before they issue an insurance policy, rent an apartment or give them a job.
In this article, we'll explore the five biggest things that affect your score: what they are; how they affect your credit score; and what it all means when you apply for credit.
Which corresponds to your score
Your credit score indicates whether you have a history of financial stability and responsible credit management. It can range from 300 to 850, but the higher the score, the better. Three credit agencies – experian, equifax and transunion – create credit scores (also known as FICO scores) based on the information in your credit file. Each agency will report a slightly different score, but they should all paint a similar picture of their credit history. Here are the elements that make up your score and how much weight each aspect carries.
1. Payment history – 35
The most important component of your credit score is whether you can repay money that has been lent to you. This component of your score considers the following factors:
- Have you paid your bills on time for each account on your credit report? Paying bills later will negatively affect your score.
- If they paid late, how late were they – 30 days, 60 days, or 90+ days? The later they are, the worse it is for their score.
- Do you have any of your accounts in collections? This is a red flag to potential lenders that you may not pay them back.
- Do you have dues deductions, debt settlements, bankruptcies, foreclosures, lawsuits, wage garnishments, liens or judgments against you? These are some of the worst things to have on your credit report from a lender's perspective.
2. Amounts owed – 30%
The second most important component of your credit score is how much you owe. The following factors are considered:
- How much of your total available credit you have used? Less is better, but owing a little can be better than owing nothing, because lenders want to see that when you borrow money, you are responsible and financially stable enough to pay it back.
- How much do you owe on certain types of accounts, e.G. B. Mortgages, car loans, credit cards and installment accounts? Credit scoring software wants to see that you have a mix of different types of credit and that you manage them all responsibly.
- How much do you owe in total and how much do you owe against the original amount in installment accounts? Again, less is better.
3. Length of credit history – 15%
Your credit score also takes into account how long you have used credit. For how many years have you used credit? How old is your oldest account and what is the average age of all your accounts?
A long history is helpful (if it is not affected by late payments and other negative items), but a short history can also be fine as long as you have made your payments on time and do not owe too much. ..
4. New credit – 10%
Your FICO score takes into account how many new accounts you have. It will show how many new accounts you have recently signed up for and when you last opened a new account.
The scoring assumes that you may be a greater credit risk if you have recently opened multiple new accounts. People tend to open new accounts when they have cash flow problems or plan to take on a lot of new debt.
For example, if you apply for a mortgage, the lender will look at your total monthly debt as part of determining how much mortgage you can afford to borrow. If you have recently opened several new credit cards, this could indicate that you plan to make a number of purchases on credit in the near future, which means you cannot afford the monthly mortgage payment that the lender has estimated. To obtain. Lenders can't determine what to lend based on something they might do, but they can use their credit score to assess how much of a credit risk they might be.
5. Types of credit in use – 10%
The last thing the FICO formula takes into account when determining your credit score is whether you have a mix of different types of credit, such as credit cards, branch accounts, installment loans and mortgages. It is also studied how many accounts you have in total. Since this is a small component of your score, you don't need to worry if you don't have accounts in each of these categories. You also can't open new accounts just to increase your choice of credit types.
What is not in their score
The following information about you is not considered in determining your creditworthiness, according to FICO:
- Marital status
- Age (although FICO says that some other types of scores they consider this)
- Race, color, religion, national origin
- Receiving public assistance
- Salary
- Occupation, employment history and employer (lenders and other scores may take this into account)
- Where you live
- Child / family support obligations
- Any information that is not included in your credit report
- Participation in a credit counseling program
What it means when you apply for credit
The following guidelines will help you maintain a good score or improve your credit score:
- Watch your credit utilization ratio. Keep credit card balances below 15-25% of your total available balance.
- Pay their accounts on time, and if they are late, they should not be more than 30 days late.
- Do not open many new accounts at once
- Check your credit score about six months in advance if you want to make a major purchase, such as buying a house or a car, that you need to take out a loan. This gives them time to correct possible errors and improve their score if necessary.
- If you have a bad credit score and many mistakes in your credit history, do not despair. Just start making better decisions and you will see incremental improvements in your score as the negative elements in your history get older.