What is a credit score?

While the topic of one's credit score might not make for the most riveting conversation at the dinner table, it is, in fact, of the utmost significance. Your credit score is one of the primary factors that can influence whether or not you are granted a mortgage, a loan, or a credit card. It can even influence whether or not a landlord will rent to you. Additionally, it is a significant factor in determining the interest rate that will be applied to loans and credit card balances.

Your credit score is determined by your payment history, the amounts owed, the length of your credit history, the new credit you've opened, and the mix of credit you have. These five key factors are derived from the information contained in your credit reports.

In the following paragraphs, we will dive deeper into each of the five factors and analyse how they influence your credit score.

What exactly constitutes a credit score?
Credit scores are typically expressed as three-digit numbers and can range anywhere from 300 to 850. Lenders will look at this score to determine whether or not they will extend you credit. According to their point of view, the higher your score, the greater the likelihood that you will repay any loans or credit card debt that you have. Bringing your credit score up to a good or excellent level can make it simpler for you to qualify for loans and credit cards, and it can also improve the interest rates that are offered to you when you apply for these types of credit.

It is a widespread misunderstanding that each individual only has one credit score. In reality, there are a great number of distinct models for calculating credit scores, and different lenders may use different scores for a variety of purposes.

FICO, for instance, is the credit score that is used the most frequently in the United States. FICO is responsible for the creation of both base credit scores and industry-specific credit scores, such as those used by auto lenders and credit card issuers. Additionally, it routinely updates the credit-scoring models that it uses; however, your score may change depending on the model that a particular creditor employs.

Although the ranges for credit ratings from poor to exceptional can differ from one credit-scoring model to another, the following scales are used by FICO:

Bad credit, ranging from 300 to 579
Credit equivalent to 580-669
Good credit: between 670 and 739
Very good: 740-799
Exceptional: 800-850
Nevertheless, the FICO score is not the only credit score available. VantageScore is a competitor to FICO that provides credit scores, and card issuers, lenders, and other creditors may use them in addition to FICO scores.

The following ranges are used when calculating VantageScore:

Very poor: 300-549
Bad credit, ranging from 550 to 649
Credit equivalent to: 650-699
Good credit is between 700 and 749.
Excellent: 750-850
In addition to FICO and VantageScore, the three major credit bureaus also generate their own credit scores by using the information in their own credit reports. Lenders may also choose to use their own proprietary credit-scoring models in place of or in addition to FICO and VantageScore. To put it another way, if you check your credit score, you should be aware that there is more than one score available to you.

What factors go into determining a person's credit score?
However, credit-scoring companies do reveal the fundamentals of which factors affect credit scores and how they are calculated. Credit-scoring algorithms are industry secrets, but credit-scoring companies do not disclose them.

Your credit reports are the starting point for everything. Your credit score is based on five factors, which are your payment history, amounts owed, length of credit history, new credit, and credit mix. These factors are reported on a regular basis by your creditors. Experian, Equifax, and TransUnion are the three credit bureaus that receive this information when it is reported. Each credit report includes information that can include your history of making payments on credit accounts, whether or not you have any accounts that have been turned over to collections, as well as other personal data and public records such as filings for bankruptcy.

Your credit score is the result of this information being turned into a number that is simple to understand. Imagine it like your final grade point average from school; all of your tests (i.e., credit activity) are included on your credit report, and the credit score is the equivalent of your final grade point average.

Your credit scores might not be identical if they were calculated by the same company due to the fact that there are a number of different companies doing the calculating. They can be different from one another depending on which credit report the score is derived from and which credit-scoring model is utilised.

The impact that each of these five aspects has on your credit score.
The following is a breakdown of how much weight is given to each of the five factors that go into determining your credit score. It is essential, especially if you are working to improve your score, to have a thorough understanding of each component and the weight that it contributes to the total score.

The history of payments (35%)
Your history of making payments is the single most important component of your credit score and accounts for 35% of the total score. Your payment history will show whether or not you have been timely with payments for loans and credit cards in the past. It also takes into account other information regarding your payments, such as the number of occasions on which payments have been late and the length of any period during which payments have been overdue.

If your payment history is dragging down your score, you might be able to raise it by paying your bills on time in the future. This will depend on the severity of the problem. It is possible for a late payment to remain on your credit report for as long as seven years; however, the negative impact of the late payment will lessen over time if you maintain a positive payment record.

Outstanding balances (30%)
Your credit score is based in part on the amount of revolving debt you have, which includes credit cards and other lines of credit but does not include installment loans. This accounts for 30% of your credit score. The reports take into consideration not only the total amount that you owe across all of your revolving accounts but also the total amount that you owe across each individual account.

Your credit utilisation ratio is determined by the credit bureaus based on your "amounts owed." This is an extremely important figure. Your credit utilisation ratio is the percentage of your total credit limit that corresponds to the amount of credit you have actually used. The calculation is performed for each individual credit account as well as the overall sum for all credit accounts. (This does not take into account loans with monthly payments, such as mortgages or auto loans.)

To determine your credit utilisation ratio for a specific card, divide the amount that you currently owe on that card by the total credit limit associated with that card. For example, if you have a credit card with a limit of $4,000 and you currently have a balance of $1,000 on that card, your credit utilisation ratio for that card is 25%.

To determine your overall credit utilisation ratio, first add up all of your outstanding balances on your various credit cards, then divide that total by the total amount of available credit you have across all of your accounts.

A credit utilisation ratio that is too high (either individually or overall) will have a negative impact on your credit score. This is because it indicates to lenders that you may have difficulty managing the revolving credit debt that you have taken on. In order to keep a good credit score, it is recommended by credit specialists that you keep your credit utilisation ratio below 30 percent.

Tip: The credit utilisation ratio is one of the few aspects of your credit score that you have the ability to change quickly and effectively, which will lead to an increase in your credit score. If you pay down the balances on your credit cards and any other accounts that use a revolving line of credit, you may see an improvement in your credit score as soon as the following billing cycle.
The length of time you've had credit (15%)
Your credit score is determined in part by the length of your credit history, which accounts for 15% of the total. It is founded on the following three primary considerations:

The length of time that your credit accounts have been active in the marketplace (including your oldest account, your newest account and the average of all your accounts)
How much time has passed since particular credit accounts were opened?
How much time has passed since you last logged into particular accounts?
In most cases, the length of your credit history has a direct bearing on the quality of your credit score.

You can get a rough estimate of the length of your credit history by adding up the number of years that each of your credit cards has been open, then dividing that sum by the total number of cards you have. This will give you a rough estimate of the length of your credit history. If it's the year 2022 and you opened credit card accounts in 2020, 2018, and 2010, for example, the average length of time you've had credit is six years. Be aware that the length of time your average account has been open will decrease each time you open a new account, which could have a negative impact on your credit score.

For as long as they remain on your credit reports, closed accounts will continue to have an effect on the length of your credit history and may also have an effect on other factors. After they have been paid off or closed, accounts do not immediately vanish from your credit reports. This can take up to two billing cycles.

Instead, the credit bureaus remove them according to a schedule that is derived from the history of payments made. After ten years, a closed account will be removed from your credit report if you have never been late with a payment on that account. If, on the other hand, you were late with a payment, the account in question will be removed from your credit reports seven years after the very first time you were late with a payment.

Ten percent for new credit.
The remaining 10% of your credit score is determined by the number of new credit accounts for which you apply and the amount of time that has passed since you opened a new account.

When you apply for new credit, a lender will pull your credit report in order to evaluate your application. This is known as a "hard enquiry." Each challenging enquiry will result in a loss of a couple of points for the overall score. Even though they remain on your report for two years, the impact of hard inquiries becomes less significant over time.

Multiple hard inquiries in a short period of time may send the message to potential lenders that you are a high-risk consumer, which may result in the denial of your application. However, if the inquiries stem from rate shopping for a mortgage, auto loan, or student loan within a 45-day window, then the majority of lenders will count it as just one hard enquiry. This is because rate shopping is considered to be a single enquiry.

It is important to be aware that soft inquiries, which take place when you check your own credit score or when a creditor preapproves or prequalifies you for an offer, do not have an effect on your credit score. This is due to the fact that you are not actually applying for new credit when the inquiries are received.

Credit mix (10%)
Your credit mix is made up of the various kinds of credit accounts and loans that you hold, such as credit cards, retail accounts, installment loans, mortgage loans, and accounts with finance companies.

Lenders will see that you are able to competently manage various types of financial obligations if you keep a diverse variety of accounts at different institutions. There is no requirement that you have at least one of each type, but having a diverse collection can help your score.

It's possible that some industry-specific credit models give more weight to previous experience with a particular category of accounts. It's possible, for instance, that a history of on-time payments on a car loan will have a more positive impact on an auto-industry score than it will have on a general credit score.

What won't have a negative impact on your credit score?
Your credit report may contain some of your personal and financial information; however, this information does not factor into the calculation of your credit scores. These are the following:

regardless of factors such as age, gender, sexual orientation, race, nationality, ethnicity, or place of residence
Your resources, employment standing, or job title, if applicable.
Affiliations with a particular religion or political party
Marital status
The interest rates that you are currently paying on your accounts.
Whether you rely on government aid or have sought the assistance of a credit counsellor,
Things that aren't included in your credit report in any way.
How to Keep Your Credit Score in Good Standing
When you have a solid understanding of the components that go into calculating your credit score, you will have a good idea of how you can raise that score. The good news is that the actions you take to keep a good to excellent credit score and the actions you take to improve a poor to fair one are the same. They are as follows:

Always pay your bills on time, and try to pay them in full whenever you can.
Keep your balances low at all times.
It is best to refrain from closing your credit card accounts.
Make an effort to avoid opening a large number of new accounts, particularly all at once.
Make use of a wide range of different accounts.
In addition to this, you should monitor your credit score frequently. Not only can you pinpoint areas that need to be improved, but disputing errors that have been made on your credit report can help you recover your score if the item that is being disputed has had a negative impact on it.

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