Understanding Your Credit Score
The credit score is an indication of a consumer’s financial reputation. Creditors use the consumer’s credit file to grant or deny loan applications and to set the loan’s interest rate. The credit score is therefore very important when it comes to borrowing large sums or even applying for certain positions. I previously wrote an article on Understanding Your Credit Report, you can read it here. Today, let’s take a look at another credit lingo, the Credit Score!
What is a credit score?
Your credit score is a three-digit number, typically between 300 and 850, which represents your credit risk, or the likelihood you will pay your bills on time. The FICO® Score is the most widely used credit score by U.S. lending institutions for their risk assessment needs. Lenders and other institutions provide credit bureaus with information on consumer bills and debts paying habits. Based on these information from your credit report, each of the three main credit bureaus (Experian, Equifax, and TransUnion) assigns you a credit score. Therefore, each consumer in the U.S should have three credit scores. In general, a higher credit score represents a higher likelihood of responsible financial habits.
Some companies and organizations use credit scores to predict your likelihood of paying back a loan and making payments on the due dates. Your credit scores can also be important when you want to rent an apartment or apply for a job. A good credit rating usually starts in the range of 700 and a rating of 750 or higher is considered excellent. Companies like IdentityIQ offer credit monitoring services which include credit reports and credit scores from TransUnion, Equifax, and Experian.
Decision to grant or deny credit
Lenders use credit reports and credit scores when deciding whether or not to grant credit. In general, consumers with scores below 600 may have difficulty qualifying for loans, while consumers with scores below 700 will likely be charged a higher interest rate than those with scores above 700. Certain credit issues – such as high credit usage or late payments – may make it difficult for you to qualify for credit. Also, not having a credit history could be as bad as having bad credit.
The main factors affecting your score
FICO Scores are calculated using five categories: payment history (weights 35%), amounts owed (30%), length of credit history (15%), new credit (10%) and credit mix (10%). Scores take into account all of these categories, not just one or two. The importance of each factor (piece of information) depends on the information in your entire credit report. Scores take into account both positive and negative information on a credit report. Certain credit monitoring companies like Idendity IQ also let you do some simulations & forecasting and provides you with steps you need to take to improve your score to a desired level. CLICK HERE TO GET A ONE WEEK TRIAL on IdentityIQ.
Below is a general breakdown of the factors and weights used to calculate your credit score:
Payment History (35%): The payment history factor evaluates your debt-paying habits. It shows whether you pay your bills on time and considers whether you have any bankruptcies, any current or unpaid outstanding debt, or any debt transferred to a collection service.
Amounts Owed (30%): One of the most important factors that is part of your credit scores is the percentage of available credit used. The use of credit represents your rate of use of revolving lines of credit (for example, credit cards). Although having accounts with balances does not increase your risk as a borrower, owing a lot on several accounts may indicate you’re stretched thin financially. It is generally recommended to stay below 35% utilization of your credit lines.
Length of Credit History (10%): This represents the age of each business line on your credit report individually and in total. A short credit history could have a negative effect on your credit score, but it isn’t a deal breaker if the accounts that you do have are paid on time. In general, the longer an account is open (used and paid on time), the higher the positive impact on your credit score. Therefore, closing old accounts could damage your credit scores as it shortens the length of your credit history.
New Credit (10%): New account opening activity and any recent inquiries from lenders on your credit report. This includes credit card and loan requests, as well as some apartment rental or job application requests. To a lender, a flood of newly opened lines of credit is generally a red flag and represents higher risk. However, your credit report differentiates between shopping for multiple new lines of credit and comparing different rates to open one new account.
Credit Mix (10%): The various types of credit accounts you have also affect the calculation of your credit rating. It is best if you have access to more than one type of credit. This is due to the fact that lenders and credit bureaus want to see that you have well managed several types of debt (revolving debt such as credit cards and installment debt such as personal loans, student loans, auto loans, and mortgages). This category will consider your mix of credit, including revolving accounts (such as a credit card) and installment accounts (such as a mortgage or student loan).
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