Personal Finance: How is Your Credit Score Calculated?
Everyone knows that having a good credit score is extremely important. A good score will make it much easier for you to buy a car, buy a home, and fulfill any other financial dreams you may have. However, many people do not know how their credit score is actually calculated. What are the components that make up your score?
There are many different credit scoring models, but here is a general breakdown of what factors are considered:
Payment History – 35%
Credit agencies consider your payment history to be the most important aspect of your overall score. Here, they are looking at how well you have repaid your student loans, car loans, credit cards, lines of credit, and any other form of credit that you have been given. Late or missed payments may count against your score. They will also take into consideration how late a payment was when deciding what impact it has on your score.
Credit Utilization Percentage – 30%
Under the credit utilization category, agencies are looking at exactly how you are using the credit that has been extended to you. They are looking to see what percentage of your overall available credit are you actually using each month. For example, if you have a credit card with a $10,000 limit, but only have a balance of $1,000 on it, your score here will be great. If, however, you have a balance of $9,000 on that card, your score will take a hit. Generally speaking, you need to be below around 25% utilization to have the best scores.
Length of Credit History – 15%
Lenders value a borrower who has shown that they can manage credit over a long period of time. So, if you just opened your first credit card six months ago, don’t expect to score too highly in this category. Your parents, however, may have been successfully managing their loans and credit cards for over 25 years – they will score very well in this category.
New Credit – 10%
Your credit score will reflect the number of new credit accounts that you have opened (or attempted to open) recently. If credit agencies see that you are applying for a lot of different forms of credit over a short period of time, they may conclude that you are managing your credit badly and will reduce your score as a result.
Types of Credit – 10%
Here, the agencies are simply looking at the different types of credit that you have. If you just have one credit card, you will score badly here. If however, you have a few cards, an auto loan, student loans, and a mortgage, you will score quite highly in this aspect. Greater variation in types of credit is what they want to see.
For those trying to increase their credit score, it is worth studying these categories closely to learn exactly where to focus to achieve the best results. With some patience and planning, you too can have a great score.