How credit score is calculated.
There are several calculations that are used to determine a credit score. They include payment history, debt ratios, the total amount of money borrowed and more. Find details on how credit scores are calculated, as the higher your rating the more opportunities you have.
It's important to understand what goes into your credit score and how it is calculated. It will be used to determine if you can get a loan, buy a house, and a rating can even impact whether you get a job or not. Your credit score is a three-digit calculation ranging from 300 to 850. The closer to 850 the better, and 300 is the worst number. The rating is based on the information in your credit report. The first step to improving it is to know what goes into, and makes up, the calculations.
What is a credit score?
It is a summary of your credit history going back several years at minimum. The number is based on many factors. A score is really a snapshot that gives banks and lenders an idea of whether or not you're a good credit risk. They will use that number to help determine whether you should receive a loan, mortgage, credit card or other funds.
The use of credit scores has been evolving. As an example, it is being used today by businesses for everything such as determining your car insurance premiums and even whether you get that job you interviewed for. Many landlords and property owners use it to determine whether they will rent you an apartment. The number is used in an ever increasing number of ways as well, so it is very important to have a good credit score.
Stay up to date on your credit scores, calculations and reports. This can easily be done. A free credit report is available at annualcreditreport.com. Be sure to check it for omissions or errors. If you find any mistakes or incorrect data that are hurting your score, report it immediately.
Calculations that determine a credit score
The following are the major criteria used to calculate credit scores. Each one of them has a different impact.
1) Payment history - This accounts for about 35% of your credit score. It reflects whether you have made your payments on time and whether you have any past-due accounts. All types of payments will impact this, including rent, mortgages, car loans, credit cards and others. Late or missed payments will have a negative impact on your credit score.
- As noted, payment history is 35% of your score. The most important step is to just pay your bills on time. If you pay late, that is the number one issue that goes into your calculation and leads to debt collectors, judgments against you, repossessions, lower credit ratings, and much more, all of which is negative.
2) Credit utilization (your level of debt) - This accounts for about 30% of your credit rating. It reflects the amount of credit you are using compared to the today amount you have available to borrow. It's generally recommended to keep your credit utilization below 30%, as using a high percentage will indicate to lenders that you are overextended and may not be able to make your payments.
- Utilization is used to calculate 30% of your credit score. Keep your outstanding debt low. Using just 10% of your credit limit is preferable and will lead to the best scores. If that is not possible, it should never be greater than 50%. There are different steps to take to reach these targets. You can either pay down debt, or increase your credit limits. Both of these will have the same effect.
3) Length of credit history - This accounts for about 15% of your number. It reflects how long you have had credit accounts and how long it has been since you used them. A longer history can be beneficial to your score because it shows that you have a track record of managing your finances and the amount of money borrowed responsibly over a longer period of time.
- Sign up for new credit wisely, and be prudent. You should not take the bait for every card or loan offer offer you get in the mail, no matter how tempting, or do not sign up for the credit card that will give you a at the department store. So always think about the impact to your calculation before borrowing more money. The more attempts you make to get credit for any type of bank or lender, and the more credit requests completed, the lower your rating will be.
4) Credit mix - This is the number and diversity of loans and accounts that are currently open. This accounts for about 10% of your credit score. It reflects the variety of accounts you have, such as credit cards, loans, and mortgages. All of these go into the overall calculation. Having a diverse mix of credit accounts can be beneficial to your because it shows that you can handle different types of credit responsibly.
- Be sure to use different types of credit to impact to influence this calculation. For example, having a mortgage, car loan, credit cards, and a personal loan show you can manage several types at once and will lead to higher scores.
5) New credit, including how many times you tried to get a new account - This accounts for about 10% of your rating. It reflects the number of new credit accounts you have and the frequency with which you apply for a new account. Taking out new loans, borrowing more money,. or opening several new credit accounts in a short period of time can be seen as a red flag by lenders, as it may indicate that you are overextending yourself and may not be able to make your payments.
- This calculation, as well as the others above, will be negatively impacted if you close accounts. Part of your credit rating is determined by how long you've used a credit card and have you been able to manage the various accounts responsibly. Building trust over time is very important for consumers. Closing an account, or taking a new loan or account in time, shortens that credit history and lowers your score.
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