How Your Credit Score Is Determined
Everybody knows that your credit score is one of the most important financial factors when it comes to getting a car loan, credit card, or mortgage but, what factors determine your credit score? This article will explain how the credit bureaus determine your ever so important credit score.
Knowing how your credit score is determined can really help you to build, or maintain a good credit score. A good look at your credit report can also help you to know what to do to improve a damaged credit score because you can see exactly what financial mistakes you have made and try to rectify them.
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Your credit score is assigned a number, which is used to gauge how efficient you are when it comes to handling credit or debt. You credit score is managed by three main credit bureaus: Experian, Equifax, and TransUnion, which are also known as FICO scores.The scores from each agency might differ by a very small amount, however it still gives a very good indication on how you manage credit. Below are the ranges that are used to classify your credit which is seen by all lenders:
720-760- very good
There are 5 main factors that are used to asses and determine your credit score which will be explained in detail below. Each factor is assigned a percentage which shows how much each factor is considered when determining your credit score.
Payment History (35%)
This is the largest factor that is considered when determining your credit score. Lenders, whether it be a bank, or credit card company want to know how reliable you are when it comes to making your payments. This payment history is not vague either, it is a very detailed report for every payment that you have made. It should be noted that the longer the information has been on your record the less it will impact your credit score.The details which are considered are as follows:
- every single billing account you have had, including loans and credit cards and even cell phone bills are all displayed separately and recorded. Obviously, any late payments that occur will be displayed and will have a negative effect on your credit score. It will show what type of payment plan it was such as, a deferred payment plan, or if a payment isn’t accepted at this point of time, such as a student loan.
- under each account it will display how many late payments have been made, as every single late payment is recorded, as well as how late the payment was. The later your payment was made the more detrimental it will be for your score. It will show how late the payment was, whether it be 10 days late or 30 days late.
- it will show very detailed information such as any payments that have gone to collection agencies. Anything that goes to collection agencies is a major red flag and very detrimental to your credit score. Other detrimental items that are displayed include: detailed information such as any foreclosures, debt settlements, bankruptcies, judgements, wage attachments and even more.
Amounts Owed (30%)
The amount that you currently owe is the second largest factor that is considered when determining your credit score. When looking at amounts owed, the following details considered are as follows:
- how much of your total available credit is currently being used is considered highly. This is where the frequently talked about 30% rule comes into play. It is a rule of thumb not to use more then 30% of all of your available credit. For example, if you owe $3000, you should not have more then $900 of your credit used. This is because if your income were to be reduced you would have a difficult time paying down your debt. Furthermore, It is important to note that it can be better to owe a little bit of money then to owe no money at all.This is because lenders what to see that you have shown the ability to borrow money, and effectively make payments on the money borrowed.
- how much you owe for different types of loans is looked at closely. The amount you owe for each credit card, mortgage, car loan etc. are all highly considered. If you have different types of loans, it is considered a good thing, as it shows that you have the ability to handle different types of credit and hopefully manage them efficiently. For example, if you had a car loan, mortgage, and credit card show on your record, it could actually be better for your credit then just having one of the above on your record.
Length Of Credit History (15%)
The amount of time that you have had a credit score is the third largest factor when determining your credit score. It might seem unfair to be penalized if you have not had a credit score for a long enough time, however, lenders want to see how you handle loans over a longer period of time. This is why it is important to get started with credit at a young age.
- the timeline of all your loans and credit history is displayed, along with the average age of all your accounts combined displayed. A long credit history if all payments are made responsibly can go a long way in aiding your credit score. Keep in mind that something usually stays on your credit report every six or seven years before it is removed. It is important to have some credit on your report, so ensure that you have had some credit within the last few years. If you don’t have any recent credit, it will be difficult for lenders to decipher how you handle credit based on your current income and situation.
- a short credit history is still fine as long as you have made all your payments, but the longer you have had credit the better it is. There is a saying, bad credit is better then no credit, which isn’t always necessarily true, however it shows that it is very important to have some credit built up. Usually, your credit score takes 6 months to be established and if you are responsible with your loans you can see your score improve gradually every six months
New Credit (10%)
The number of times you have applied for new credit, is the next largest factor considered when determining your credit score. This includes any time you applied for a loan or credit and were accepted and denied. Keep in mind that the weighting for this factor is only 10% so while it is not the most important thing, it can still have a negative impact.
- if you have applied for new credit many times in a shorter time period, then it is viewed as a negative as your are seen as ‘credit shopping’. This means that you are going place to place seeking more credit as you want to take on more new debt and it could be seen as having cash flow problems. For example if you apply for a car loan and the lender runs your reports and shows that you have recently opened up two new credit cards, it is perceived that you are planning on making several purchases with new credit cards and could have trouble making payments on your car loan.
- lenders look at the amount of your new credit and try to determine how much of a credit risk you might be to them. If you have sparingly applied for credit, it is beneficial as it shows you are not desperate to borrow money, and that you have good cash flow where frequent borrowing is not needed.
Types Of Credit Used (10%)
The types of credit you have used, or currently have in use is the last factor considered when determining your credit score. It shows detailed information regarding different credit types you have used, and how you have managed them.
- lenders look at the variety of credit types such as a vehicle loans, credit cards, mortgages and so on. If you do not have a wide variety of credit it won’t hurt your score by a large amount since the weighting is only 10%,. This is especially the case if you are responsible with the loans you do have. Do not open different types of credit just to have them in use as this it could result in some unnecessary expenses that have no clear purpose.
- different types of loans illustrate how you handle different debt loads, or it can show that you haven’t been responsible with some of your credit. For example, if you have a debt consolidation loan, it shows that you had trouble paying some debt and needed to have them consolidated into one debt load with lower interest to help pay it down.
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Keep in mind that lenders also look at other factors in relation to the type of credit you are looking to receive such as income, total assets, and how long you have been with your current employer.