Understanding credit scores and how to improve them

 

Output: How Your Credit Scores Are Calculated

Credit scores are three-digit numbers used by lenders to assess your creditworthiness when applying for loans or credit cards, but other financial providers such as employers, landlords and insurance companies also rely on scores when screening tenants, employees or policy holders.

There are a variety of factors that can have an effect on your credit score, but five that stand out most include: 1. Payment History.

1. Payment History

Payment history is one of the cornerstones of your credit score calculation. It demonstrates your history of on-time payments to creditors, such as credit card accounts and mortgage loans, whether that means mortgage lenders or creditors like credit card providers or even just lenders themselves. A strong payment history helps lenders evaluate your creditworthiness more easily and may make qualifying for loans and credit cards easier as well as impact the interest rates and terms (such as late fees) offered to you by lenders.

Lenders typically report credit-related information to consumer reporting agencies on an ongoing basis, such as account balances and payment histories from credit cards, installment loans (such as car or student loans), and finance company accounts. Scoring models such as FICO or VantageScore use payment data from these accounts when creating scoring models that take account of them.

An impact of late payments on your credit score depends on their length. Lenders generally do not report missed payments until they're more than 30 days late, and late payments typically remain visible on credit reports for seven years.

2. Length of Credit History

Your length of credit history accounts for 15 percent of a FICO score and 20 percent of a VantageScore credit score when combined with two other factors. It helps assess your stability and dependability when managing credit accounts, so its presence usually has a positive effect on scores.

Establishing a solid credit history takes time, so newer consumers should work diligently on their behavior and pay bills on time. Authorized user status could also help—your family members or trusted friends might lend money as a sign of trust and responsibility.

Keep in mind that no single credit score applies to everyone; credit-scoring models vary across major consumer reporting agencies (also referred to as credit bureaus), such as Equifax, TransUnion, and Experian. Each agency may calculate and weight factors differently that influence credit scores differently, leading to different results with each.

3. Amount Owed

Your debt utilization ratio, also known as a debt utilization ratio, plays a large part in your score. This ratio measures how much of your balance owed is relative to each account type's credit limit (credit cards, lines of credit, and mortgage loans), with higher ratios being beneficial when lenders prefer you use no more than 30% of the total limit; always pay bills before their due dates!

However, don't assume owing money on credit accounts makes you an unsafe borrower. Your long credit history and repayment of installment loans show lenders you can responsibly handle additional debt while keeping balances low. Incorporating other factors listed here as well can boost your score; don't be put off if there is some debt on your report, as lenders still view you as an acceptable risk based on other aspects of it.

4. Credit Utilization

Your debt-to-available credit ratio, or credit utilization rate, makes up about 30 percent of your overall credit scores. Calculated by dividing the total amount you owe on each card by its credit limit; people with excellent credit often have utilization rates in the single digits, while individual card utilization rates may fluctuate depending on what balances your card issuer reports to credit bureaus each month.

Utilization is one of the key determinants in your score and could result in higher interest rates or other financial costs in the future. Thankfully, managing credit utilization is straightforward: just add all revolving balances with their respective limits together before dividing by 100 to get your utilization ratio as a percentage—experts generally suggest keeping credit utilization under 30 percent for optimal scores; however, this might not always be achievable since credit scoring models need some historical usage data in order to calculate it accurately.

5. New Credit

Consumers applying for new credit will experience inquiries on their report that may have an effect on their score if too many appear in a short period of time, though not all inquiries count against it equally; soft inquiries, such as those conducted with permission by employers, landlords, or creditors pre-approving credit offers, won't count against your score and won't lower it; additionally, mortgage lenders making inquiries as part of the approval process will typically have no negative effect.

Lacking financial security or in need of credit, excessively opening accounts or applying for too many lines of credit in short order can damage a borrower's scores, because this signals to lenders that they are experiencing financial strain and desperate for credit. Therefore, it is wise to apply only when absolutely necessary; credit cards typically have long-lasting beneficial impacts that outweigh temporary dips caused by hard inquiries triggered by applications.