How Is Your Credit Score Calculated?
While credit reports are simply a track record of your payment history, your credit score is more like your school GPA. It represents a cumulative figure that measures your financial discipline relative to others.
Creditors use your credit score to determine your creditworthiness. In fact, it is safe to say that your credit score is the most crucial factor in establishing whether you are credit-worthy or not. The higher your credit score, the less risky you appear to potential lenders.
By understanding how your credit score is calculated, you can take appropriate measures to improve it. In this post, we are going to look at the information considered when calculating your score.
Payment History (35%)
Your payment history accounts for at least 35% of your score. It is used to show whether you make payments on time or not. In fact, the first thing that any potential lender will want to know is whether you paid your past loans on time.
The higher the number of your on-time payments, the higher your score will be. Every time you miss a payment, a specific amount of points are deducted from your overall rating.
How Much You Owe (30%)
The total amount of credit you owe on loans and credit cards account for up to 30% of your score. This is also based on the proportion of amount owed compared to the total amount of credit available to you.
Having many accounts and owing money on most of them doesn’t mean that you’re a high-risk borrower. But, if you are consuming much of the credit limit available to you, it may send a wrong signal to potential creditors.
Some financial institutions may interpret such a situation to mean that you are at a higher risk of defaulting.
The Length of Your Credit History (15%)
How long have you been borrowing money and making timely payments? The longer your credit history, the higher your score will be.
While some people think that it is good to avoid applying for credit and carrying debt, the truth is it may hurt your score in the long run. Potential lenders may turn you down if they don’t have any credit history to review.
Recent Credit History (10%)
Your recent credit history makes up to 10% of your final score. Research shows that if you have recently opened a lot of credit accounts or applied open accounts, lenders will see you as a high-risk borrower.
Such activity can lower your score significantly. However, if you have maintained the same loans for a relatively long period and continue to make timely payments, your score will go up over time.
Types of Accounts You Have
Finally, the type of credit accounts you have account for the remaining 10% of your score. Having a good mix of accounts, including home loans, installment loans, and credit cards may improve your score over time. However, don’t be stressed so much if you only have one type of loan because it is not a must to have all of them.
