Your credit score is influenced by a variety of factors. Many people think their credit rating is only contingent upon how much debt they have. This is not the case. The money you owe to creditors plays a role but so do other factors as well. Here we explore this issue further.
You may wonder what exactly a credit score is. A credit score is a special number that potential lenders use when a person applies for any type of credit. For example, credit card providers, mortgage bankers and car dealerships are three kinds of lenders that will take a look at your credit score before deciding whether they should lend money to you or not. If they do decide to say yes then they will use your score to figure out what interest rate they will lend to you at. A credit score is used as a form of risk assessment in regards to the lending of money to a borrower. The better a person’s score is the better a risk they are, the worse the score is the worse a risk they are.
There are other instances where your credit score may be checked. Insurance companies might check it out to determine how responsible you are with your finances. It is also possible that property managers might look at it before they rent an apartment to you. In some cases prospective employers might even want to see it for themselves.
What Affects Your Credit Score?
In a nutshell your credit score shows how responsible you are in handling credit and whether you have a history of financial stability or not. Credit scores are numbers that range from 300 to 850. The higher your score is the better it is for you. There are three credit reporting agencies (or bureaus) in the United States. These include Equifax, Experian and TransUnion.
All of these agencies compile credit scores based on the information that is provided in your credit files. While each agency may report a score that is slightly different, the scores will be similar in nature and together will form your overall credit picture and history. Please note that credit scores are also sometimes referred to as FICO scores.
Anatomy of a Credit Score
Everyone’s credit score is made up of five components. This is how it is broken down:
• Payment History (35%)
• Money Owing (30%)
• Length of Credit History (15%)
• New Credit (10%)
• Kinds of Credit Currently in Use (10%)
Let us take a closer look at each one of these elements of a credit score.
Your payment history makes up the largest percentage of your total credit score and is considered the most important element of it. It comprises 35% of your overall score. The payment history of your score focuses in on how responsible and trustworthy you are when it comes to repaying money that you have borrowed. Whether or not you pay your bills on time each and every month and for every account is a significant part of your payment history. When you pay your bills late this has a negative effect on your score. The longer it takes you to pay them the worse it is. As well if paying late is a common practice then this works against you and will reduce your score. Prospective lenders look at this.
If any of your accounts have ever gone to collections then this sends a message to potential lenders that if they lend to you they may not get their money back. Have you ever declared bankruptcy? Are there any charge offs, debt settlements, suits, foreclosures, liens, judgments or wage attachments on your file? If yes then any of these items can have a very negative impact on your record. Many of these items can remain on your record for anywhere from seven to 10 years. Unfortunately from the perspective of a lender certain elements of your payment history work against you.
The second most significant aspect of your credit score is the amount of money you owe. This makes up 30% of your overall score. This part of your score looks at how much of the available credit you have that you are presently using. Owing less is preferable but borrowing a little is good because it shows potential lenders that you can borrow money and then pay it back in a responsible and timely fashion.
Lenders also consider how much you owe on the various accounts you have. This includes your mortgage, your credit cards, car loans, personal loans and installments accounts, etc. Lenders are looking to see what type of credit you have and whether you are financially stable enough to manage it responsibly. This also takes into account the amount of debts you have when they are all totaled up as well as how much you owe now compared to when the account was first opened. The less you owe the better your score will be.
Length of Credit History
How long you have been using credit is the third element of your credit score. This accounts for 15% of your total score. For how many years have you been a consumer of credit? How old is the oldest account on your record? In general what is the average age of the accounts you currently have?
As a general rule a long credit history provides stability for your score as long as you do not have a history that is full of negative items such as late payments or missed payments.
However everyone must start somewhere. A short credit history is a starting point and is fine as long as it shows that you do not owe too much and that you are very conscientious about making your payments on time.
The number of new accounts you have is a part of your credit score. When you last opened a new account and how many new accounts you have applied for in the recent past matter too. New credit accounts for 10% of your credit score. You become more of a credit risk if you have opened several new accounts in a short period of time. This may seem like an unfair assumption but what often happens is that people have a tendency to apply for and open new accounts when they either plan to take on new debts and/or are having some cash flow issues.
Kinds of Credit Currently in Use
The last item that rounds out your credit score is worth 10%. It is the kinds of credit that you are presently using. Prospective lenders take into consideration the combination of credit that you are using as most people use more than one form of credit at a time. This may include mortgages, personal loans, business loans or car loans, credit cards and store accounts. How many accounts you have on the go figures in here.
What Your Credit Score Does Not Reflect
There is certain information about you that credit agencies do not know and therefore these things do not influence your credit score. For example, your age and marital status is not reported, nor is your occupation, your income or your history of employment. If you were ever on public assistance then this will not be reflected on your score. Rental agreements are not found here. If you ever participated in a credit counseling program this will not show up either.
How to Improve and/or Maintain a Good Credit Score
It is important that you take care of your credit score because as long as you use credit you will have a credit score. In other words, it is with you for life! There are things you can do to improve and maintain your score.
Pay close attention to your credit utilization ratio. This is the percentage of credit you use in comparison to how much you have available to you. It is wise to keep the balances on your credit cards below 15 to 25% of the amount of credit you have available. Make an effort to pay all of your accounts on time. If you must pay something a little bit late than make sure it is no later than 30 days.
Do not open a whole bunch of new accounts within a short time frame. If you plan to apply for a house loan or a loan to buy a car then check your credit score approximately six to eight months in advance of doing so. This will allow you the time to correct any mistakes and to improve your score if necessary.
If your credit score is less than perfect and your credit history is flawed then do not let it get you down too much. Consider it a worthy challenge and an obstacle that will provide a steppingstone to success. Do what you can to make improvements and begin to make more responsible choices with your use of credit. The more time and distance that passes the more the bad things will recede into your credit past. As well they will mean less and less over the passage of time.