Our credit scores are so important in the functionality of our financial lives that it isn’t surprising that so many people wonder how exactly credit companies calculate their credit scores.
Credit scores, or FICO scores, are the tools that are used to help lenders determine if there is a risk when they lend to a borrower.
There are several factors that contribute to credit scores. When your credit score looks a bit shoddy, you can repair it and companies who will help, such as Lexington law credit repair. However, it is better to not have to repair it.
Knowing what affects your credit score is the first step in preventing it from reaching this point.
Your credit score is calculated through a variety of different factors, although FICO does not actually reveal the formula they use to calculate your score, we do know that it is made up of a selection of 5 main components.
These include your payment history at around 35% of your credit score, the amount you owe at around 30%, the length of your credit history at 15%, any new credit at around 10%, and a mix of credit at 10%.
All of these will be taken into account when FICO calculates your score. This can range from 300 at the lowest, to 850 at most. There is no singular factor that will determine what your score is overall.
Let’s take a look into each of these 5 key factors individually and how they contribute to your overall credit score.
Remember, that no single one of these solely has an impact on your credit score.
The history of your payment will take into account if you have always paid on time and with consistency. It is also the factors that will consider any previous collections, bankruptcies, and delinquencies.
However, it also considers the size and scale of these issues as well, and how long it was taken to resolve these issues. The amount of time since the issues arose is also considered a well.
If you have more problems in the history of your credit, then your score will be lowered. One problem cannot lower your score by hundreds of points, however, multiple issues could do so.
How much you owe also takes up a large amount of your credit score. This is primarily a reference to the amount currently owed in comparison with what credit you have.
This means that lenders who notice high spending will assume that you will spend above your limit. Therefore, you are a possible risk. They will also likely want to view utilization ratios. Hence the % of credit which you use, at a rate below 30%.
While this does mean it factors in current debts, it will also look at how many accounts you have, and the specific accounts you have. If you have a large amount of debt from varying sources then this will have a bad effect on your overall credit score.
It is not all that surprising that how long you have had a credit account open will affect your credit score. If your credit account is older and has a good standing then this is ideal.
If you have never been late with a payment in over 10 years. Then you are a safer person to lend to than someone who has only been on time for 3 years.
New credit is also a consideration. If you often apply then it can show you as being in a bad financial situation. Therefore, whenever you apply your credit score may be affected slightly.
Hence, when you open a new credit account, then it is smart to think about how this new bit of credit will affect your credit score. Is it really worth that much to have it? Consider the risk you are taking by opening that account.
Lenders ideally want to see that you have a good and healthy mix of credit. They also want to see you are capable of managing various types of credit. This means that it is ideal to have both revolving credit and installment credit.
Revolving credit includes; retail store cards, credit cards, gas station cards, and lines of credit. Installment credit includes; auto loans, personal loans, student loans, mortgages, and so on. Having a healthy variation can show abilities to manage money and financial intelligence.