A credit score is an important number that can affect several aspects of your financial life. Whether you want to apply for a loan, buy a house, or even get a new credit card, your credit score plays a key role in determining whether you’ll be approved and what interest rates you’ll receive. But have you ever wondered how this score is calculated? It’s not just a random number; it’s based on several specific factors that reflect your credit behavior.
In this blog, we’ll explore how many factors are taken into account when calculating a credit score. Understanding these important factors can help you in managing your credit more effectively and improve your score over time.
What Is a Credit Score?
Before exploring these important factors that influence your credit score, it’s important to first grasp what a credit score actually represents. A credit score is a numerical measure that reflects how reliable you are in handling credit. It usually falls within the range of 300 to 850. The more credit score, the more trustworthy you appear to lenders. Banks, credit card providers, and other financial organizations check this score to determine whether they should approve your loan or credit card application and what interest rate(IR) they should offer you. A better credit score improves your chances of getting approved and could also help you secure better interest rates.
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How Many Factors Are Taken Into Account When Calculating A Credit Score?
A credit score is checked based on details from your credit report. Your credit report is a detailed record of your credit history, including your borrowing and repayment behavior. The information in your credit report is collected by credit bureaus, like Equifax, Experian, and TransUnion, which then use this information to calculate your credit score.
There are several different models for calculating credit scores, but the most commonly utilized is the FICO score. The FICO score considers five main factors, each of which contributes to your overall credit score. Let’s explore these factors in detail.
1. Payment History (35% of Your Credit Score)
Payment history is the most important factor in calculating your credit score, making up 35% of the total score. This factor reflects how consistently you have paid your bills on time. Lenders want to know if you have a history of paying your debts as agreed, as this is a strong indicator of how likely you are to repay future loans.
If you have a history of late payments or missing payments, it can impact your credit score in negative way. Whereas, a good and consistant record of on-time payments will help improve your score.
Tips to Improve Payment History:
- Always pay your bills on time. Setting up auto payments or reminders can really help you avoid missing due dates.
- If you’ve missed a payment, try to make it as soon as possible to minimize the impact on your credit score.
2. Credit Utilization (30% of Your Credit Score)
Credit utilization, also known as amounts owed, accounts for 30% of your credit score. This factor measures how much of your available credit you are currently using. It is calculated by dividing the total amount you owe on your credit cards by your overall credit limit.
A high credit utilization rate, such as using 80% or more of your available credit, can be a red flag to lenders. It may suggest that you are overextended and at a higher risk of defaulting on your debts. On the other hand, keeping your credit utilization low (ideally below 30%) is a positive sign and can help boost your credit score.
Tips to Improve Credit Utilization:
- Try to pay your credit card amount as much as possible. Reducing your overall debt can significantly improve your credit utilization ratio.
- Try avoiding maxing out your credit cards, and try asking a higher credit limit if you can manage it responsibly.
3. Length of Credit History (15% of Your Credit Score)
The length of history of your credit accounts for 15% of your credit score. It looks at how long you’ve had credit, including the age of your old account, the age of your new account, and the average age of all your accounts.
A longer credit history is generally viewed more favorably by lenders because it provides a more extended track record of your credit behavior. If you have a short credit history, it doesn’t necessarily mean you will have a low credit score, but it can limit your score’s potential.
Tips to Improve Length of Credit History:
- Keep your oldest credit accounts open, even if you no longer use them regularly. Closing oldest accounts can shorten your credit history and negatively impact your score.
- Be cautious when opening new accounts, as this can lessen the average age of your credit history.
4. Types of Credit Used (10% of Your Credit Score)
The kinds of credit you use, called your credit mix, make up 10% of your credit score. This looks at the different types of credit you have, like credit cards, car loans, mortgages, and store accounts.
Having a different mix of credit types can be helpful to your credit score, as it shows that you can handle or manage different types of credit responsibly. However, it is not necessary to have every type of credit account, and this factor has less impact on your score than others.
Tips to Improve Credit Mix:
- If possible, try to have a mix of credit types, like a credit card and an installment loan. However, only take on new credit if you truly need it and can manage it responsibly.
- Don’t open new credit accounts solely to improve your credit mix; it’s more important to focus on managing the accounts you already have.
5. New Credit (10% of Your Credit Score)
New credit accounts for 10% of your credit score and looks at how many recent credit applications and new accounts you have. When you apply for credit, lenders usually do a “hard inquiry” on your credit report, which can slightly reduce your score.
Opening many new credit accounts in a less time can be seen as a risk by lenders, as it may indicate that you are trying to take on more debt than you can handle. However, this factor has a relatively small impact on your overall credit score.
Tips to Manage New Credit:
- Try to avoid applying for several new credit accounts within a quick time frame. Each new application results in a difficult inquiry, which can lower your score.
- Only apply for new credit when necessary, and be mindful of the impact it may have on your credit score.
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Conclusion
Your credit score is determined by 5 major factors: payment history, credit usage, length of credit history, types of credit, and new credit. Each of these factors plays a different role in determining your overall creditworthiness. By understanding these factors and managing your credit responsibly, you can enhance your credit score over time.
Remember, a good and better credit score can help you open doors to better financial opportunities, such as lessen interest rates on loans and credit cards, so it’s worth taking the time to understand and improve your credit score.