Credit score… a mysterious number that you may not often think about, but has a great influence in your life. When you apply for a new credit card, go to purchase a new car, or even decide to buy your first home, you are evaluated by your credit score. This number gives the bank or lender nearly everything they need to know in order to decide to extend credit to you—and at what rate, so it even affects your monthly payments. We are going to take a credit score deep dive to look at the five factors that affect your credit score.
This post is sponsored by CreditRepair.com. All opinions are mine alone and are honestly conveyed.
What is a FICO Score?
So, if your credit score has such an impact on your financial life, it is important to understand what it is, what factors cause it to change, and what you can do to make it as high as possible. Your credit score is also referred to as your FICO score. FICO is an acronym used to represent the Fair Isaac Corporation—the company that creates the credit scores that the majority of creditors use to determine creditworthiness. Your FICO score, or credit score, is a number ranging from 300-850, which indicates your future credit risk. FICO calculates the credit risk based on historical patterns of credit behavior. Creditors will use this number to determine whether or notthey will to lend to you, the maximum amount of money that they will lend to you, and at what interest rate they will lend to you. In reality, your credit score determines much of your budget because any loan that you have been approved for has a payment based off of the qualifying program and rate.
How many credit bureaus are there?
Creditors use your FICO score to calculate the risk of extending credit to you. But your credit score isn’t just one number—you actually have three credit scores. There are three different credit bureaus: Transunion, Experian, and Equifax. These agencies receive information about you from your current creditors and compile that information into a credit risk score. Some creditors send and receive information from only one of the credit bureaus, some use all three. Each credit bureau only uses the information—both positive and negative—that is supplied to it by the creditors that utilize that particular bureau. So it is very important to know what is reporting to each bureau and work to make sure that all information that is reporting is accurate and updated.
How is my credit score calculated?
There is no quick answer to explain exactly how your credit score is calculated. Unfortunately, the exact formula is not known. However, we do know the factors that are used in calculating your credit score. And understanding how these factors are used can help you to improve your credit score. There are five main factors that FICO uses to calculate your credit score:
Types of accounts that you have open (10%)
The overall number of accounts that you have open currently, and the types of accounts that they are, makes up 10 percent of your FICO score. What type of accounts do you currently have open that are reporting to the bureaus on you? Credit cards, installment loan, mortgage loan? Each type of loan is different in the way that they function regarding term, payment, and interest calculation. Showing that you have experience successfully managing all types of debt will have a positive impact on your score.
Number of recent credit inquiries/new accounts (10%)
While this is only a small percentage of your score, it is an important one. Opening too many accounts too quickly can drive down your credit score. Because new accounts have not had time to report a solid payment history, these accounts can make your credit appear risky and uncertain. Many people also don’t realize that when you are shopping around for a mortgage, or a car loan, or even looking to open a new credit card, you don’t want every creditor to pull your credit. Most are able to provide you with a general idea of the programs that are available to you at certain credit levels. If you have a good idea of what your credit score is, you can decide which creditor you want to go with and only allow that creditor to perform a credit check.
Length of credit history (15%)
Another factor that is taken into consideration is the length of your credit history. If you haven’t had accounts opened for very long to show a consistent willingness to make your payments on time, it can be hard for creditors to predict what your future payments may be. Regardless of how long or short your credit history is, or how many accounts you have reporting on you, make sure that the payments that are showing up, are made on time!
Level of debt, as compared to available credit (30%)
Your credit score is also calculated based upon how much you owe. Have you spent to the limit on all of your credit cards? Or have you shown that you can manage your debt in a disciplined and controlled way? A good “rule of thumb” to follow is to keep your credit card balances at or below 50 percent of the credit card’s maximum limit. For example, if you have a credit card that has a limit of $5000, try to keep your balance at or below $2500, so as not to impact your credit score negatively.
Payment history (35%)
Last, but certainly not least, is payment history—and this factor accounts for the largest percentage of your credit score. Payment history is the most important to creditors because it shows your willingness and ability to actually repay a loan. If you are currently making your payments on time and have a history of doing so, then it is reasonable for creditors to believe that you will pay back a new loan that a potential creditor may extend to you. This causes your risk level to decrease and your credit score to increase.
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