Your credit score is three small numbers that hold a lot of power.
A good score tells lenders that you are a safe bet for a mortgage, car loan, or business loan. It allows you to open credit card accounts and determine your interest rates. Even landlords research credit scores when evaluating potential tenants.
Credit scores are tabulated using information in your credit reports, but how exactly does that work? Five factors are most important in determining your score.
How your credit score is calculated
FICO, the most widely used credit scorer, collects your financial information from the three major credit bureaus, Experian, Equifax and TransUnion. It then assigns a score anywhere from 300 to 850.
The credit bureaus have different data collection criteria, so your score may vary slightly between the three. If you don’t know your credit score, it’s easier than ever watch it for free, to see where you stand.
FICO bases scores ranging from “very poor” to “exceptional” on these five things:
Your payment history: It counts for 35% of a FICO score.
Your credit usage: It counts for 30%.
The length of your credit history 15%.
Your credit mix: 10%.
New credit: 10%.
As you can see, the categories vary in importance. Let’s take a closer look at them all.
1. Payment history
Since payment history carries the most weight, it is critical that you pay your credit on time. Even late payment has a negative impact and can remain on your file for up to seven years. It becomes less important over time as you catch up on your bills and stay up to date.
Debts being collected are even more damaging, so don’t let your creditors come after you. Call them at the first sign of trouble, preferably before the bills are due or overdue.
Many lenders will work with you on a repayment plan or schedule a more suitable due date. Taking out a debt consolidation loan can help you get your debt under control – and boost your credit.
2. Use of credit
A debt to credit ratio compares how much credit you use to how much you have available. To calculate it, add up all of your balances due. Then add up all of your spending limits. Divide the first total by the second to get your occupancy rate.
Creditors frown on ratios above 30%. If your spending limit on a card is $ 6,000 and your balance is $ 2,500, your occupancy rate is 42%. That will hurt your credit score.
Using zero to 10% is ideal, so work on paying off your balance before going into more debt. And don’t be too quick with canceling credit cards, as that can decrease your available credit and potentially increase the percentage of credit you use.
3. Length of credit history
There’s another good reason not to be too eager to close accounts, even after you’ve made the very last payment: Lenders prefer to do business with borrowers who have experience in credit.
FICO takes into account the average age of all your accounts and the age of the oldest. Provided your file is spotless, maintaining long-term relationships with creditors improves your creditworthiness.
4. Credit mix
The combination of credits you use won’t weigh as much as the first three categories, but it’s worth bearing in mind.
Lenders like to see that you can manage different types of accounts responsibly.
5. New credit
New credit is also a lesser factor in determining your credit score, and it is one that can help or hurt your score.
A new account can increase the amount of credit you have at your disposal and keep your credit usage lower. But a wave of credit applications all at once can ring alarm bells. Lenders will wonder if you’ve been fired from work or are living on an oversized scale.
If you’re trying to build a more robust credit mix and increase your score, do it gradually. Don’t apply for a mortgage, a car loan and three credit cards all at once.
Other things that may or may not affect your credit score
Your FICO score does not reflect your assets, income, occupation, or age.
Your history of paying utilities, phone bills, and other expenses didn’t have an impact before, but that could change. For example, Experian now offers to factor in the monthly bill payment if it will improve your score.
When you apply for a new credit, questions from lenders can slightly affect your score. It usually recovers after you pay on time for a few months. Meanwhile, check your score yourself has no impact.
VantageScore: an alternative to FICO
Another credit scoring model called VantageScore is catching on. The criteria are similar to those of FICO, but the categories are weighted differently.
Here’s how the latest VantageScore version, VantageScore 4.0, is calculated.
Payment history: It counts for 41% of a VantageScore.
Credit usage: It counts for 20%.
Credit history and mix: 20%.
New credit: 11%.
Available credit: 2%.
Introduced in 2017, VantageScore 4.0 places less importance on past credit behavior. You will love that feature if you have an affected plate but have changed your ways.
The VantageScore website recommends keeping your debt-to-credit ratio below 30%, diversifying account types, and keeping accounts in good condition and open for as long as possible.
In several ways, VantageScore is more generous than FICO. Scores are not affected by paid or unpaid collections less than $ 250. Accounts affected during a natural disaster will not be considered.
Knowing the score – and keeping it nice and high – can make all the difference in the quality of your financial life. If you are using a service that provides you with a free credit score, make sure you are offered it free credit monitoringalso.