Nothing has as much power over your financial future as your Credit Score. If you can wrap your head around five factors of a Credit Score, you’re well on improving your financial outlook. If you are new to Credit Scores or want to refresh your knowledge, you have reached the right spot. In this article, I will discuss Credit Scores and what defines a good or a bad Credit Score. And I will share with you five factors that affect your Credit Score.
What is Credit Score?
Imagine this, your good friend since high school calls and asks to borrow $500 for house repairs. He promises to pay you back with Interest. Then, later that day, while in line at the grocery store, a stranger asks you to lend him money and promises to pay you with Interest. Which of them are you going to lend your money to? To your friend, Right? You know him better than the stranger at the store.
A long time ago, borrowing money was super difficult. Some loan officers would base their approval on whether or not they already knew you. Others based it on your reputation in the community. And don’t even get me started on non-related factors like your Upbringing, Nationality, Gender, or skin color. It was dark times, and not only that, it was exhausting. Getting a loan would take forever.
So, a new system was created to know if you are credible or not: Credit Scores. A Credit Score is a number given to you based on your Credit History over the previous five to seven years. These days, three separate credit bureaus, Equifax, TransUnion, and Experian, keep track of this data. If your record is excellent, you will have a good Credit Score, and obtaining a loan will be easy with favorable terms. But, it will be difficult for you to get a loan if your Credit History is inconsistent. It means you have a poor Credit Score. A low Credit Score sucks, but it isn’t the end of the world either.
Credit Score Service Provider
I wanted to share a few of the key fundamentals with you. Hopefully, it will help you stop falling victim to this powerful and annoying number. The best-known variety of Credit Scores is “FICO” and VantageScore.”
VantageScore emphasizes total credit utilization and balances. At the same time, “FICO” focuses on payment history. These form the basis for your credit report. But results vary depending on how they evaluate your data and how much importance they give certain elements.
A Credit Score can range from 300 to 850. Anything over 650 means a good performance, and a 750 Credit Score indicates an excellent rating. But if you are below the 650 Credit Score, start thinking of more ways to climb the ladder. Contrary to what you might think, a zero Credit Score does not mean you are a bad borrower; it only tells the lender that you have never carried any debt.
For some people, not taking on debt is a good thing, but if you want to maintain a healthy Credit Score, you should have at least one active account. Keep a few Credit Card accounts active and pay them weekly. It will help you maintain a positive rating in your credit report and boost your Credit Score.
The 5 Factors of Credit Score
Your Credit Score is based on five factors, Credit Mix, New Credit, Length of History, Payment History, and Credit Utilization. Let us look at each and see how big of an impact they have.
#1 Payment History
The first and most important factor is your “Payment History.” Payment History accounts for around 35% of your overall score. It makes sense since a good Payment History allows creditors to trust you with their money in the future. On-time payments make your Payment History flawless, but if you pay late, your Credit Score suffers. Late payments can stay on your credit report for up to seven years.
#2 Credit Utilization
The second factor is “Credit Utilization.” It accounts for about 30% of your score. Credit Utilization tracks how much you owe to your total available Credit. For example, if you have a ten thousand dollar Credit Card limit and owe one thousand dollars on it, that is a ten percent Credit Utilization.
Contrary to popular myth, a good credit rating does not come from never using Credit. Not using your Credit at all is worse than using it responsibly. You want to present to creditors that you can manage a reasonable debt. It demonstrates your dependability as a borrower.
#3 Credit History
Factor number three is your “Credit History.” One of the more visible criteria is the length of your credit history, which accounts for 15% of your Credit Score. It relates to the average age of all your open accounts. So, if you opened a Credit Card account six years ago and have kept it active, your Credit History is six years. Once a loan is paid off or you close a credit account, it is no longer included in the calculation. It can lower your Credit Score.
Remember, this is the average length of time. So, if you have a two-year-old account in a six-year-old account, your credit history comes out to four years. That is why if you pay off an old account, it can lower your Credit Score. The longer you have been borrowing, the better for your Credit.
#4 Credit Mix
The fourth factor is your “Credit Mix.” This one accounts for around 10% of your Credit Score. Lenders appreciate it when they see that you have a range of active accounts. Having a Car Loan, Student Loan, Mortgage, and a few Credit Cards is better than having all your money tied up in just one of them. It demonstrates your responsibility and ability to manage many forms of debt—the more diversified your Credit, the better.
#5 New Credit
The last factor is “New Credit.” It accounts for 10% of your Credit Score. New Credit considers how frequently you take out Credit or apply for loans. Some creditors request a copy of your credit report when you apply. And if it is a hard inquiry, it will appear on your credit report.
It can negatively impact your Credit Score. Try to limit these to one a year on average. Any more than that, and banks will start to worry that you are overextending yourself. Knowing your Credit Score is just the first step.