Among all the numbers in your life, your credit score is the most important when it comes to your financial future. Your score can affect whether you get a loan, credit card or apartment; how much you can borrow; the interest rate you pay; or even whether you land a job! Here’s some basic information about what makes up your score and how scores work.
Your credit score is a number representing your ability to repay a loan and the likelihood that you will meet the obligation. It is based on your entire borrowing history and calculated by various credit reporting agencies through a proprietary formula. When determining your credit score, credit bureaus use something called the FICO score. Approximately 90% of lenders use this score in making lending decisions.
Commonly, credit scores range from 300-850. The higher the number, the better your score. The lower your number, the higher the level of perceived risk for lenders. Often, as an incentive for lending to riskier individuals, banks charge higher interest rates to shore up these accounts.
Credit scores from the three bureaus are typically calculated in similar ways, with slight variations between different bureaus. The main factors in a credit score calculation, ranked by relative importance are:
- Payment History: This factor equals roughly 35% of the total weight in most credit scores from reporting institutions. This means you should avoid late payments at all costs.
- Credit Utilization: This makes up 30% of your credit score, and it’s made up of several components
- The amount of debt still owed to lenders
- The number of accounts with debt outstanding
- The amount of debt owed on individual accounts
- The lack of a certain type of loan (in some cases)
- The percentage of credit lines in use on revolving accounts, like credit cards
- The percentage of debt still owed on installment loans, like mortgages
- The best way to avoid a negative mark here is to keep your balance below 30% of your credit limit for each credit card you use.
- Length of Credit History: This is 15% of most credit scores. The older your credit accounts are, the better. It is helpful to have a long history of consistent payments.
- Types of Credit: 10% of your score. This factor looks at how many sources of borrowing you use (e.g. car loan, mortgage, credit card, retail store card, etc). The more unique sources of credit you use, the better it is for your score.
- New Credit: Also 10%. This assesses the number of new credit accounts. After opening a new line of credit, experts suggest waiting at least six months before opening another.
Credit scores are complicated, but knowing a bit about how reporting agencies calculate your credit score can go a long way to helping you improve it. Whether you’re building, or rebuilding your credit, this simple advice will help you plan for your financial future and whatever life may throw your way. Consider some of our resources for financial planning, debt consolidation, refinancing, and financial literacy by following these links: BalancePro, Credit Builder