If you’ve ever thought that credit scores are a little bit confusing, worry no longer. In this article, we’re going to go over how your score is calculated. This should give you a better idea of what you can do to boost it up.
The higher the three-digit number, the better. First of all, having a good score can open a lot of doors for you. It’ll show loaners that you’re responsible with money, so you won’t have any issue opening more accounts as needed.
That being said, keep in mind that scores vary from person to person. They’re highly personalized, so how they’re calculated is different for everybody. For example, if this is your first time opening a credit account, your numbers will look different from someone who’s had one for several years. As your spending habits change, so will your data.
Categories and General Percentages
Generally, here are the categories financial companies look at: payment history (35%), amounts owed (30%), length of credit history (15%), new credit (10%) and credit mix (10%). These are very general percentages, but it should give you an idea of which of these numbers count more than the others. Looking at your own score should give you a better idea of which areas need improvement and which don’t.
Credit Score Vs Credit Decisions
These are two very different things. When applying for credit, your credit score is taken into consideration, as are other things pertaining to your financial life.
To put it simply, in the decision-making process, your lender might look at your income or how long you’ve worked a certain job. As for credit scores, some might or some might not use this information. To give you an idea of what to expect, here’s a list of things FICO scores don’t take into account. FICO is used by 90% of top lenders, so it’s likely this is the number you’ll be looking at a lot.
- Race, national origin, religion, marital status, and sex (prohibited by US law)
- Your age
- Occupation, title, salary, employee, date of employment and history
- Child/ Family support obligations
- Where you live
- Your current interest rates
- Consumer-initiated, Promotional or Administrative inquiries
- Information not proven to be predictive of future credit performances
So with that out of the way, let’s look at all the categories mentioned earlier in depth.
The first thing any lender wants to know is whether you’ve paid past credit accounts on time. This helps a lender figure out the amount of risk it will take on when extending credit. This is the most important factor in a FICO Score.
Be sure to keep your accounts in good standing to build a healthy history.
Lenders want to avoid as much risk as possible. That’s why they’ll take a good hard look at your payment history to determine whether or not you’ve paid past credit accounts on time. These will include credit cards, mortgage loans, installment loans, finance company accounts, and retail accounts.
Bankruptcies and lawsuits will negatively affect your score as well and, late payments will also be thoroughly combed. How late you were and how much you owed will make its mark but don’t forget your score will also be dependent on how recently this has happened as well as how many times.
No, owing money will not automatically peg you as a high-risk investment. This part of the score will determine whether or not you’re overextending yourself by looking at the percentage of available credit you’re using up.
More specifically, your credit utilization score will play a big role. It’s important to stay on top of it, and you can do so with a little bit of maths. Grab a pen and paper!
Let’s assume your credit card balance is $2,000 while your total credit limit is $10,000. Divide your balance by your limit. In our example, you’ll come up with 0,2. Multiplying that number by 100 will give you a nice and round percentage number (20%). Lenders appreciate 30% or less, it signals that you can make sound financial decisions.
Length of Credit History
Long credit histories are good, they’ll boost your score. But don’t worry, if this is your first time using credit, you could still have a pretty big score depending on all other factors.
Of particular interest will be the age of your newest and oldest accounts, as well as the average age of all your accounts.
Again, your credit score will consider your credit cards, retail accounts, finance company accounts, mortgage loans, and installment loans. Having one of each is not a necessity, jut know that they’ll affect your score when you open them. That’s why financial advisors will dissuade you from opening anything you don’t actually want to use.
This is especially important for first-timers, as it’ll give lenders information they could not pull from someplace else. So, how many and what type of accounts you have plays a part. Then again, closing an account won’t make it go away, it’ll still be a part of your financial history.
People who open a lot of credit accounts very frequently will be seen as greater risks by lenders. Inquiries will also show up on your credit report, indicating that you’re ready to shop around for new credit. But these don’t stay on for very long, and you can consider them gone in about two years.
Not only that but inquiries have a small impact and some of them are ignored completely, so don’t stress out too much!
So, there you have it. Have we managed to shed some light on how your credit score works? Knowing all of these, what are the first steps you’re going to take in order to improve yours? If you’re unsure, check out this article on 8 easy ways to improve your credit score.