Have you ever thought about how credit scores are calculated? or why certain financial decisions appear to impact your credit score greater than other ones? To clarify this process, we’ll dive into the enigma of credit scoring models in general and explore the most important elements that affect your score on credit.
This vital three-digit code is a key element in your finances, affecting everything from how you can get mortgage loans to the amount of interest you’ll have to pay for credit card debt. So, buckle up and get ready for an intensive course in credit education.
The Meaning of Credit Score
In simple terms the credit score is a reflection of your creditworthiness. It’s a numerical report of your credit history based on your accounts, payment habits for bills as well as the type and number of accounts that you’ve got, your outstanding debts, and other variables. It’s similar to an financial report card with credit card companies, as well as some employers looking over it to determine how well you manage your finances.
There are a variety of credit scores to choose from, but the most commonly used are FICO Score created by the Fair Isaac Corporation, and VantageScore created by three of the major credit bureaus, Equifax, Experian, and TransUnion. Scores generally vary between 300 and 850 with higher scores indicating a higher risk of credit.
Major Credit Scoring Models
FICO Score and VantageScore are two most popular credit scoring models for credit scoring. Although they both use a lot of the same data that you get from your credit report however, they compute credit scores differently.
FICO scores have been in use since the 1980s and are utilized by a wide range of lenders. This scoring model puts a lot of weight on your past payment history and the amount owed and is followed by the length of your credit history, credit mix and even new credit.
However the VantageScore was introduced in 2006, was a cooperative effort by the three main credit bureaus to develop an improved and consistent scoring system. While it also focuses on the history of credit and payment and credit utilization, it is able to score those with less credit history which allows more people to obtain credit scores all over.
Five Factors that Influence Your Credit Score
1. Payment History
Your payments history — whether you’ve completed your credit card or loan payments on time is among the most important factors that affect both FICO as well as VantageScore models. Incorrect or late payments particularly those made in the recent past could seriously impact your score.
The payment history also includes information about your account like whether you’ve had accounts referred to collections or filed for bankruptcy. Be aware that some negative information may remain on your credit file for seven years or more.
2. Credit Utilization Ratio
The credit utilization ratio is the percent of your credit you’re using. It is calculated by dividing your total balances on credit by your credit limits total.
Credit scoring models typically penalize excessive usage rates that they interpret as a sign of financial difficulty. The ideal goal is to maintain your ratio under 30 percent on each account on your credit card as well as across all of your credit lines that are revolving.
3. The length of credit history
The length of your credit history is about 15 percent of your FICO score. It takes into account the ages of your oldest credit card and the mean age of your various accounts as well as the age of particular account types.
A long-standing credit history usually leads to a higher score, because it provides more details about your borrowing habits.
4. Credit Mix
Credit mix is a term used to describe the kinds of accounts that are included on your credit reportlike retail accounts, credit cards installment loans (like mortgage and auto loans) Finance corporate accounts, and many more.
A mixture of revolving and installment credit proves that you can manage various types of credit. This variety can positively impact credit scores. While it’s not essential to have all of them the two, managing various debt products will show the ability of managing a variety of financial obligations.
5. New Credit Inquiries
Every time you make a credit application, it could lead to a hard inquiry or an account of the lender looking into your credit in connection with your application. These inquiries can impact the credit score of your client, particularly when you receive multiple inquiries within an extremely short time. This is due to the fact that potential lenders may see the number of inquiries as evidence you’re in financial trouble, or may be taking on too much new debt.
How to Increase Your Credit Score
The first step is to understand how your credit score is calculated. to getting it improved. Let’s take a examine ways to improve your credit profile:
- Pay on time: Pay all your bills on time including the cost of utility bills, loan repayments and balances on credit cards. This will establish a reliable payment history which is an important factor in calculating credit scores.
- Monitor your credit utilization ratio: Maintain your credit card balances at a low level when compared to your total credit available. If you are able you can make sure to pay your balances off in the full amount every month.
- Don’t close credit cards: Unless a card has an annual fee and you want to keep it open. The more credit you have available from credit accounts open can lower your ratio of credit utilization.
- Stop new credit requests: Apply for new credit accounts only when required. Not only do hard inquiries impact your credit scores, but opening multiple new accounts in a short time could lower the age average of your credit accounts.
- Mix up your credit: Over time, try to show that you can manage various credit types responsibly, including auto loans, credit cards as well as installment loans.
Understanding Credit Reports
A credit report provides a thorough report of your credit report, provided by credit bureaus. It includes the kinds of accounts that you’ve got, the amount of time they’ve been in operation and whether you’ve been able to pay your bills in time, and whether you’ve declared bankruptcy or had an injunction against you.
Each credit bureau gathers details about your credit history. However, this information could differ between bureaus since not all creditors submit their information to the three bureaus. You’re entitled to a free credit report from each of the three credit bureaus (Equifax, Experian, and TransUnion) every 12 months through AnnualCreditReport.com.
Common Misconceptions about Credit Scores
There are many myths associated with credit scoring. Here are a few of them:
Myth: Checking your own credit report can hurt your credit score.
Truth: This is a soft inquiry that doesn’t impact credit scores.
Myth: You need to maintain an account on your credit card to establish credit and get a high credit score.
Truth: You don’t need to carry a balance of debt in order to have an excellent score. You can make use of your credit card to pay the balance completely every month, which could aid in achieving a high credit score.
Myth: All credit scores are the same.
The truth: Different credit scoring models can yield different scores. For example your FICO credit score might differ from the one you have on VantageScore.
Conclusion
Knowing the way your credit score is calculated will help you to manage your financial wellbeing. By keeping track of the main factors that affect your credit score such as the history of your payments, credit utilization as well as the length of your credit history, mix of credit and the new credit you have -you can make informed choices that will help increase your credit score over time.
Remember that a high credit score can lead to a myriad of financial options. Be vigilant and make your payments in time and aim to build a diverse and balanced credit portfolio for the best results.
FAQs
Does closing a credit-card account impact my credit score?
It’s true that closing your credit card account can adversely affect your credit score. It can reduce your overall credit available, which could increase your credit utilization ratio and can also impact the age average of your credit cards.
If I cosign on a loan, does it impact my credit score?
Yes, cosigning a loan could affect your credit score. If the principal borrower does not pay on time your credit score may be affected since you are also accountable for the loan.
Can employers check my credit report?
While employers may request a copy of your credit report with your permission However, it is important to note that this report doesn’t contain the credit score. Instead, it includes details concerning your credit history.
If I have a bad credit score, is it still possible to get a loan?
It is possible to obtain an loan even with a poor credit rating, however it could be more difficult. You could receive more expensive interest rates or terms that are less favorable as lenders might view you as a riskier borrower.
How often should I check my credit score?
It is recommended that you review your credit report at least once a year. This will help you identify any mistakes and help you keep an eye on the credit score. Remember, you’re legally entitled to a free credit report from all three credit bureaus each year.
How quickly can I improve my credit score?
The amount of time needed to boost your credit score relies on a variety of factors such as the type of negative information on your credit report and your score and your financial habits. Certain changes can lead to an increase in your score faster and others might take longer.
Do utility payments impact my credit score?
The majority of utility companies don’t report timely payment to credit bureaus. However, they might make late payments that could negatively impact your credit score. However, certain credit scoring systems, including the latest versions of VantageScore are beginning to include other data sources like utility bills in their calculation.
