How is your Credit Score Calculated?

How is your Credit Score Calculated?


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Your credit score is a 3 digit number that to consumers may look like no big deal, but to lenders, employers, and insurance agents, it says a lot.

Your credit score tells lenders and others how well you handle your finances. FICO scores (which most lenders use) range from 300 – 850, with 850 the highest possible score. Only 1 percent of the population achieves this, so don’t think you need a crazy high score, but knowing what impacts your credit score helps you achieve high scores.

What Information do Credit Bureaus Use?

So how do the credit bureaus get your information and how do they use it?

Most creditors that you have debt with report your account to the credit bureaus. They report how much you borrow, if you pay it on time, and your outstanding balance. Most creditors report the information monthly.

Any negative information, such as late payments, racking up too much credit card debt, or taking out too many loans at one time may hurt your score.

What Affects your Credit Score?

Now let’s look at the breakdown of your FICO score factors. Today’s scoring model uses five factors to calculate your credit score.

Payment History

Your payment history makes up 35 percent of your credit score. It’s the largest portion of your credit score, so pay your bills on time.

Just what does on time mean? Normally, you’d think paying your bills on time means on the due date and yes, you should pay your bills on time. But credit bureaus don’t ‘mark you late’ until you make your payment more than 30 days late. If you miss your due date by 30 days, the creditor reports your late payment to the credit bureaus and it negatively affects your credit score. The negative effects worsen the longer you don’t make a payment. For example, if you still don’t make your payment after 60 days, it drops your credit score even further.

Once you bring your account current, though, your credit score will bounce back slowly. The more time that passes after the late payment occurrence, the less it affects your credit score.

Credit Utilization

Another one of the most important credit factors is your credit utilization. The amount of debt you have outstanding at one time affects your credit score.

Here’s an example.

You get a new credit card with a $1,500 credit limit. It’s tempting to run out and charge up to $1,500, right? Don’t do it. Your credit score will fall. The ‘magic number’ for credit utilization or the amount of credit that’s outstanding compared to your credit limit is 30 percent. In our example, it means you shouldn’t have more than $450 outstanding at one time.

Credit utilization makes up 30 percent of your FICO score factors, so it’s another influential factor on your credit score.

Length of Credit History

The length of your credit history is 15 percent of your credit score. This factor measures how long you’ve had your credit.

Let’s say when you turned 18 you opened a department store credit card. Then when you turned 20 you got an unsecured credit card and a personal loan. If you keep the credit cards open (the department store card and unsecured credit card), you ‘age’ your credit. In other words, you show lenders and the credit bureaus that you can handle your credit for long periods. Your personal loan won’t help much in the age category since it’s a short term loan and ends eventually.

Once you have a few accounts, the credit bureaus take an average of the age. The more new accounts you open, the younger your credit age becomes, which is one of the credit factors that negatively affect your score.

New Credit

Remember the new credit we talked about above? The credit that hurts your average credit history length and therefore hurts your credit score is the same one that may hurt your credit score again.

When you have new credit, you are risky. You added a new liability to your budget. When the debt is new, it lowers your credit score slightly. New credit makes up 10 percent of your credit score.

When you think about what determines your credit score, think of not only new credit that you open but also new inquiries. Every time you apply for new credit, the lender pulls your credit score. This reports on your credit report as an inquiry.

While inquiries themselves only hit your credit score 5 points, if you have too many inquiries, it signals financial desperation to lenders. Not only does it lower your credit score, but it may decrease your chances of securing loan approval.

Mix of Credit

The last of the credit factors affecting your credit score is the mix of credit. In other words, this is your chance to show off your ability to handle different types of credit.

If you have all credit cards, you have a lot of revolving debt. That’s risky to lenders since you can reuse revolving debt as you pay it off. Having a mix of revolving debt and installment debt, though, shows lenders you can handle different types of debt at one time and hopefully pay them on time.

If you have too much revolving debt and you pay those bills late, it hurts your credit scores in both categories, lowering your score.

Knowing what impacts your credit score is important, as there are many categories you must consider. While you must pay your bills on time, as it makes up 35 percent of your credit score, the other FICO score factors play an important role too.

Only take on debt you can handle and try to mix up your account types so you have several types of debt available. Show lenders you can pay your bills on time, manage different accounts, and don’t have an abundance of new credit when you want to apply for a new loan.


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