Understanding credit scores can be confusing to some people. It is no wonder. While credit scores are one of the most important parts of living in today’s world, they are not usually taught in school. You, more or less, have to learn this on your own.
In simple terms, consider your credit school the way you would think of a grade in high school. The teacher uses all of the information he or she has on you (test scores, attendance, homework grades, etc) and comes up with a final grade for you. Some of the information he or she uses is more important in determining that grade than other information but in the end you are given a grade.
Credit scores are calculated in the same way, more or less, but instead of using test scores and book report scores it takes into account the information that is on your credit reports.
Credit scores would be useless to lenders if they were not standardized in some way, and they are. A score can range anywhere from 300 to 900. Where you fall within that range gives lenders an idea of how creditworthy you are. You want a high score. You should also understand that your credit score can vary with time and circumstances. It can go up and it can go down.
The manner in which a score is calculated is a secret, but here are some approximations on how it works.
About 35 percent of your credit score is based on your past payment history. This is one of the reasons it is important to pay your bills on time. Your credit score will be affected by how many bills you have paid late, how many of those bills were sent out for collection, if there are bankruptcies on your record and so forth. The more recent these things happened, the more weight it carries.
Approximately 30 percent of your credit score will be based on outstanding debt. In other words, how much money do you owe right now on other loans. This also applies to how many credit cards you carry and the credit limits that you have on those cards. In simple terms, the more cards you have maxed out, the lower your score will be. A fairly good idea is to always try to keep credit card balances at 25 percent or less of their limits.
Another 15 percent of your credit score is based on the length of time that you have had credit. The longer you have had credit transactions, the better.
A little known fact is that about 10 percent of your score will be based on the number of credit inquiries made on your report. If you have applied for several credit cards or other types of loans, you will have several inquiries listed on your credit reports. These look bad because to lenders they may indicate that you are in financial trouble. The more recent these inquiries have been made the lower your score will be. FICO scores only count inquiries from the past year so there is a time cutoff on these.
The last 10 percent is based on the types of credit you have right now. This might include the number of current outstanding loans and the available credit you have on credit cards that you already have. This type of information is used when you do not have a lot of credit history for the lender to use in order to make a decision.
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