Your financial well-being is greatly impacted by your credit score. They are so crucial, in fact, that a whole business is dedicated to tracking and reporting your credit score.
What does that three-digit number actually signify, then? In a word, it demonstrates to lenders how responsibly you handle your debt and finances in general.
You are viewed as a “good” credit risk if you pay your bills on time and don’t have a lot of debt. This makes it simpler to obtain loans, credit cards, or a mortgage and, while doing so, secure the lowest interest rates. Your credit outlook won’t be as favorable if you frequently fall behind on your payments or have large credit card balances.
Understanding how your credit score functions doesn’t require you to be a genius. For more information on credit reporting and scoring, see our simple guide.
Issuance of credit reports
Experian, Equifax, or TransUnion provide credit reports and credit ratings. Your credit report is created by these three organizations using data from your creditors.
What to anticipate on your credit report is as follows:
- Information about you personally, such as your current and previous addresses, Social Security number, and employment history.
- A list of all of your credit accounts, along with their balances, payment histories, and most current activity
- Public documents relating to debts, including foreclosures, bankruptcies, and wage garnishments
- The number of times in the past two years that you have applied for fresh credit.
There’s a chance that your credit reports from the various credit bureaus won’t match. You might find information on one of your reports that isn’t included on the other two because lenders can choose which bureaus they report to.
Credit scores in numerical order
Your credit score is determined using all the data in your credit report. Your FICO score, which most lenders use to determine your creditworthiness, is based on five distinct factors:
1. Payment history (35% of the total) – A higher score is earned by paying on time. Damage from late payments, past-due or overdrawn accounts, bankruptcies, and liens can be severe.
2. Debt-to-credit ratio (30%) – Also known as “revolving utilization,” this ratio measures how much debt you have in relation to your total credit limit.
Since a smaller ratio typically equates to a higher score, your desired usage ratio should ideally be less than 10%. Your score will suffer if you are close to, or at, your limit on several cards.
Your utilization ratio may be calculated rather easily. Obtain a copy of your credit report and make a list of all of your credit card accounts, including the credit limits and outstanding balances for each. Closed accounts should not be included.
Next, total up all of your credit lines and outstanding balances. You should have two different figures that show how much you owe overall and how much credit you have received. The third step is to divide your total balance by the sum of your credit line, multiply the result by 100, and then convert the result to a percentage.
This sample will help you understand how it functions. Suppose you owe $1,500 on your credit cards but have a $25,000 credit limit overall. The math would seem as follows:
$1,500 ÷ $25,000 = .06
.06 x 100 = 6%
As you can see, your credit score benefits from the credit utilization, which is 6 percent. To find out what your utilization ratio is with each of your creditors, you may also perform this calculation separately for each card. In either case, this will offer you a solid picture of how risky a borrower you are to lenders.
Last but not least, don’t assume that if you paid in whole each month, your utilization ratio would be zero. Even if you pay your payment in full each month, you’re likely to have a balance if you’ve used your card at all in the previous 30 days because the number that appears on your credit reports is the same as the balance from your most recent statement.
1. Length of credit history (15%) – This reveals how long you’ve used credit and how you’ve previously handled your money. Keep older accounts open even if you don’t use them because the longer your credit history is the better.
2. New credit accounts and inquiries (10%) – This category comprises accounts you’ve opened recently as well as credit-related enquiries from businesses. While credit inquiries are recorded on your credit report for two years, they are only taken into account for the first 12 months for calculating your credit score. If you’re going to apply for new credit, spread out the queries over time to lessen the effect they will have on your score.
3. Credit Diversification (10%) – Having credit cards is an excellent way to develop credit, but lenders also want to see that you can handle other sorts of debt, such mortgages and installment loans.
Don’t ignore the state of your credit.
You should monitor your credit just as creditors and credit bureaus do. The three credit agencies’ credit reports should be reviewed by you at least once a year to look for errors, according to experts. Do not wait to dispute any inaccuracies you uncover in order to have them corrected.
In the end, you are accountable for your credit score. Making the grade is a test you take your entire life and are regularly graded on. Making responsible credit and payment utilization routine can help you maintain a high credit score.
