If you’re trying to improve your credit score, it’s important to understand how your credit score is calculated. While you…
If you’re trying to improve your credit score, it’s important to understand how your credit score is calculated. Although you have many different credit ratings, including VantageScoresabout 90% of lenders will ask for your FICO score when applying for credit.
There are even different versions of FICO scores, but generally five factors make up a FICO score. If you pay attention to these factors and score high, you are likely to score well with other score versions as well.
Before we get into the details of each factor, let’s start with a solid understanding of what a credit score measures and how the score is used by lenders.
What does a credit score measure?
Basically, your score is a three-digit number that reflects your creditworthiness. FICO scores range from 300 to 850. The higher your score, the less risky you are to lenders.
Here are the FICO score ranges:
— Exceptional: 800-850.
— Very good: 740-799.
— Good: 670-739.
— Fair: 580-669.
— Poor: 300-579.
When you apply for a credit card, for example, the lender will ask for your score. Your score, along with your card application and credit report, helps the issuer determine whether you should be approved or declined for a credit card.
It’s important to know your line of credit so you don’t ask for credit cards you’re unlikely to get. For example, if your credit score is 700, you have a good rating. But if you apply for a credit card that requires very good or exceptional credit, you probably won’t be approved.
How credit scores are determined
Your credit score is generated by an algorithm that uses the information in your credit report to one of the main credit bureaus. By the way, lenders don’t always report your credit history to the three major bureaus. This is why your score may vary from office to office. Not only that, but different partition versions can also produce different partition of the same desktop.
Your FICO score is made up of these five factors:
— Payment history: 35%.
— Amounts due: 30%.
— Duration of credit history: 15%.
— New credit: 10%.
— Credit composition: 10%.
Payment history: 35%
Your payment history has a huge impact on your credit score. Pay all your bills on time and you’re laying the foundation for a great credit score. Make sure you have a structure in place, such as text or email reminders, so you don’t make late payments. Seriously, a late payment can drop your score like a rock.
And I’m not just talking about credit card payments. Pay all your bills on time. No exceptions!
Amounts due: 30%
The amounts due also have a significant impact. You have a credit utilization ratio, which is the amount of credit you have used compared to the amount of credit you have. If your ratio exceeds 30%, it may lower your credit score.
Note that the FICO score algorithm looks at your ratio for each credit card as well as your overall usage ratio. So don’t try to load a debt card and expect your overall ratio to keep your score intact. Keep track of each card’s individual ratio to maintain a good score.
Length of credit history: 15%
If you’ve used credit responsibly for a long time, it certainly helps you appear creditworthy to a lender. But that doesn’t mean you can’t have a good credit score for the first few years of your life. You can focus on other factors, such as timely payments and keeping utilization rates low.
Remember that a good score comes from practicing excellent credit habits. Start using credit responsibly early on and you’ll get a great score.
New credit: 10%
There are two types of inquiries that may appear on your credit report: hard demands and soft demands. When you apply for a new credit card (or other types of credit), the lender will thoroughly analyze your credit report to determine if you should be approved for a credit card. This translates to a thorough investigation, which means your credit score may drop by up to five points.
With a gentle request, your score is not affected. You’ve probably received pre-approval letters from credit card issuers. These letters are the result of a gentle investigation. The lender reviews your report on a superficial level to determine if you might qualify for one of their credit cards. This is an example of a soft survey.
But if you request the card and the issuer reviews your report more carefully, it becomes a difficult investigation and it impacts your score.
[Read: Best Low-Interest Credit Cards.]
Credit mix: 10%
You are also rewarded quite a bit for being able to handle different types of credit, including revolving credit, installment loans, and open credit.
Credit cards are an example of revolving credit. You have a credit limit with a credit card, but you are free to use as little or as much of the limit as you want. When the invoice is due, you must pay the balance in full before the due date.
Another type of credit is the installment loan. With this type of loan, you borrow a lump sum and then repay it in monthly installments including interest. Mortgagescar loans, student loans and more personal loans are examples of installment loans.
Open credit is another type of credit. An example is your monthly utility bill, which varies. You pay for utilities after you use them, right? So if you pay your utility bill promptly, you are successfully managing open credit.
Now, don’t go out and buy a car to tap into the credit mix category of your FICO score. As you progress through life, you will find that you naturally end up with a mix of credits.
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