Payment history (35%)
Payment history is the most important factor in your credit score calculation. According to Forbes, it is the record of a borrower’s payments on their credit accounts and other debts. It tracks whether you’ve paid past credit accounts on time. Late payments, missed payments, and accounts sent to collections negatively impact your score significantly. A consistent record of on-time payments shows lenders you are reliable and responsible with credit, making you a lower risk.
Credit utilization (30%)
Credit utilization is the percentage of a borrower’s total available credit that is currently being used. It measures how much of your available credit you’re using at any given time. A lower utilization rate is better for your score; generally, it’s advised to keep your utilization below 30%. This means if you have a total credit limit of $10,000, you should aim to keep your outstanding balance under $3,000. High utilization rates can signal to lenders that you’re over-reliant on credit and might struggle to pay back what you owe.
Length of credit history (15%)
The length of credit history implies how long you’ve had credit accounts. A longer credit history generally improves your score because it gives lenders more data to understand your borrowing behavior. It includes the age of your oldest account, the age of your newest account, and the average age of all your accounts. Keeping older accounts open and active can positively impact this part of your score.
Credit mix (10%)
Credit mix means having a variety of credit types, such as credit cards, installment loans, and mortgages, which can positively impact your score. This shows lenders you can manage different kinds of credit responsibly. However, it’s not necessary to open new credit accounts just for the sake of diversification. Instead, focus on maintaining a balanced mix of credit that suits your financial needs.
New credit (10%)
New Credits is how many new credit accounts you’ve opened recently. Opening several new accounts in a short period can lower your score because it suggests you might be at a higher risk. Each new credit application typically results in a hard inquiry on your credit report, which can also slightly lower your score. Be strategic about when and why you apply for new credit to avoid unnecessary dings to your score.
By understanding these five factors and how they impact your credit score, you can take proactive steps to manage and improve your credit health. It’s all about maintaining a balance and demonstrating responsible credit behavior over time.
How does a credit score work?
Some factors influencing the score are payment history (35%), credit utilization (30%), length of credit history (15%), credit mix (10%), and new credit inquiries (10%).
When you apply for credit, lenders request your credit score from one or more of the credit bureaus (Equifax, Experian, and TransUnion). The lender then uses this score, along with factors like income and employment status, to evaluate your application and determine terms. A higher score suggests lower risk, leading to better interest rates and terms.
Credit scores can change over time as new information is reported to the credit bureaus, reflecting your ongoing financial behavior. So, while your score today might be different from what it was a year ago, the key is to maintain good financial habits to keep it moving in the right direction.
What are credit score ranges and their impact?
Credit scores typically range from 300 to 850, with higher scores indicating better creditworthiness.
Higher scores (700+) generally mean easier access to credit, lower interest rates, and better terms. This translates into more savings, and a longer time on mortgages, car loans, and other financial products. Essentially, a high score opens the door to the best financial opportunities.
- Mid-range scores (600-700) may still get you approved for most credit products but with less favorable terms. You might face higher interest rates and fewer perks, making borrowing more expensive in the long run.
- Lower scores (<600) can lead to higher costs for loans, insurance, and rental applications. Some employers may also consider credit scores in hiring decisions, which means a low score could impact your job prospects.
What is a good credit score?
A good credit score typically falls in the range of 670 to 739 on the FICO scale, which is the most commonly used scoring model. This range is considered “good” because it places you above average and demonstrates responsible credit management.
While not in the top tier, a good credit score still offers many financial advantages, including access to a wide range of credit products and terms.
To access the very best rates and offers, you may want to strive for a “very good” (740-799) or “excellent” (800-850) credit score. This high score will help you to have an easy financial life with lenders giving loan approvals and competitive interest rates
What is considered a bad credit score?
Now the opposite question must be asked. “What is a bad credit score?” will get different answers depending on who you’re talking to, but many lenders would consider anything below 580 bad.
A bad credit score doesn’t just mean that you won’t be able to get a credit card with cool perks. A bad credit score can negatively impact many aspects of your daily life.
A landlord could get nervous about renting an apartment to you if you have a bad credit score. Potential employers could perform a credit check during the application process, and if they don’t like what they see, it could ruin your chances of getting the job.
Why do I have different credit scores?
You have different credit scores because multiple credit scoring models and credit bureaus exist. The three main credit bureaus (Equifax, Experian, and TransUnion) may have slightly different information about your credit history, leading to variations in scores.
Additionally, different scoring models, such as FICO and VantageScore, use unique algorithms to calculate scores, resulting in different numbers even with the same credit report data. There are also industry-specific versions of credit scores, like auto loan scores, that may weigh factors differently.
Despite these variations, your scores should generally fall within the same range if your credit information is consistent across bureaus.
Why do I need a good credit score?
A great credit score can open up a world of opportunities for you. It can help you qualify for lower interest rates on loans and credit cards, making borrowing more affordable. With solid credit, you’ll also see higher acceptance rates for all kinds of loans and financing products.
Additionally, a high credit score may increase your chances of getting approved for rental properties. This can be incredibly important, especially if you live in a competitive housing market. Some insurance companies may also offer lower premiums to individuals with good credit scores.
Overall, maintaining an excellent credit score can help save you significant amounts of money on financing products and even provide you with more financial flexibility.
How to improve your credit score
Improving your credit score takes time and effort, but it’s entirely achievable with the right approach. Here are some key steps you can take to boost your score.
- Pay bills on time: Set up automatic payments or reminders to ensure you never miss a due date. Since payment history is the most significant factor in your credit score, consistently paying on time can make a big difference.
- Reduce credit utilization: Try to keep your credit card balances below 30% of your credit limits. Pay down existing balances and consider asking for credit limit increases to improve your credit utilization ratio.
- Keep old accounts open: The length of your credit history matters, so don’t close old credit cards, even if you’re not using them frequently. Older accounts can positively impact the average age of your credit, boosting your score.
- Limit new credit applications: Each hard inquiry can slightly lower your score, so apply for new credit sparingly. Multiple inquiries in a short period can signal risk to lenders so only apply when necessary.
- Use a mix of credit types: Having both revolving credit (like credit cards) and installment loans (like a mortgage or car loan) can positively impact your score. A diverse credit portfolio shows lenders you can manage different types of credit responsibly.
- Check your credit report regularly: Look for errors and dispute inaccuracies you find. You’re allowed one free report annually from each major credit bureau, which can help you stay on top of your credit health.
- Use credit monitoring services: These can alert you to changes in your credit report and score, helping you track progress and catch potential issues early. Monitoring services provide peace of mind and can be a valuable tool in maintaining good credit health.
Tip: It’s never too late to repair your credit score. There’s always something you can do to improve it.
