A credit score is a three-digit numerical expression that represents your creditworthiness and is derived based on your credit files. Almost all financial institutions or lenders, before offering a loan, pull your credit history to assess your ability to pay back the debt responsibly. Consumer reporting agencies, also called as credit bureaus, are the offices that compile your credit data. There are three principal credit bureaus- Equifax, Experian, TransUnion.
Depending on the bureau from which the credit data is pulled and the credit model employed, there are few chief credit-influencing factors that are typically used in estimating your credit score. Be it a student loan, auto loan, business loan, mortgage, payday loan, credit card or installment loan, your credit score matters. Besides, it also determines your ability to qualify for a loan or funding; at what interest rate and what credit limits. Thus, lenders make lending decisions based on your credit score. However, having known the importance of credit score in the territory of finance is not enough; you should understand the factors that can adversely impact your credit score.
The 5 key factors and how they can affect your creditworthiness.
- Payment history– Your payment history plays a very critical role in calculating your credit score because it is a heavily weighted factor that occupies 35 percent of your total credit score. Any lender before lending any kind of loan to you wants to know the percentage of on-time payments you have made in the past. This indicates how reliable you are as a borrower. Your past long-term payment behavior that includes whether you have paid your past loans or credit accounts responsibly is used to estimate what would be your future payment behaviour or how creditworthy you are. Even a two missed or late payments can bring down your credit score. Therefore, paying your bills on time is important to maintaining a healthy credit score.
- Credit Utilization– This is the other largely weighted feature next to payment history. It represents 30 percent of your total credit score. Fundamentally, credit utilization is the proportion of your credit card balance to credit limit. Maxing out your credit limit regularly is viewed as an irresponsible debt management by credit bureaus. According to FICO (a credit scoring system used by majority of banks and other lending institutions in the United states), an average about 7% credit utilization ratio is the best because majority of the people with good credit score tend to maintain this credit ratio. However, 15 to 20 percent is also acceptable. Therefore, ensure to have lower credit utilization. This holds good not only for individual credit card but also for debt level in general.
- Length of credit history– This component accounts for 15 percent and considers how long or for how many years you have been using credit; how aged is your oldest account; and the average age of all your accounts. Having a longer credit history that is not spoiled with late payments or other unappealing things is valuable because it offers more insights into your long-term financial behavior. However, even a shorter credit history is also good, provided you have cleared all your payments timely and do not owe much. Therefore, if you have a credit and you are on a path to improve it, sustaining long-standing accounts is the key. If you are new to credit, then having an outstanding credit score is not feasible, but you should start on using credit.
- Credit mix in use– This element constitutes 10 percent of your total credit score. Generally, FICO scores will take into account a blend of your credit cards, installment loans, mortgage loans, retail accounts, etc. Therefore, repaying such a good assortment of credit is advantageous and reflects your excellent debt management skills. Besides, lenders consider these kinds of borrowers less risky.
- New credit– New credit occupies 10 percent of your total credit score. According to research, if you do not have an extensive credit history or if you are new to credit, you should not open up more than a few new credit accounts in a short time, as it is risky. Holding several accounts unnecessarily indicates poor finances. Therefore, it is advisable to take on extra credit only when really required.
Above are the biggest factors that can impact your creditworthiness largely. Therefore, pay your bills responsibly on time, keep your credit balance low, preserve established accounts, do not open up multiple accounts in a short time and you are on your best track to improve your credit score.