Whenever the mention of credit comes up concerning opening a new credit card or getting a good loan from a lender, you are presented with a number known as your Credit Score that will open either a door to good financial stability or a trapdoor into the depths of fiscal failure. But how exactly is the score calculated and what does it mean?
In short, the credit score (either FICO or VantageScore), is an expression of the value of an individual’s credit history. Credit scores can range from 300 to 850, no lower or higher. A higher score means better credit “trustworthiness” in regards to lenders, while a lower score means delinquent or derogatory credit behavior. This history includes different types of accounts, payment history, and personal information.
As mentioned above there are two types of scores: FICO and VantageScore. The short of it is that most lenders are more likely to look at your FICO over your VantageScore, and the main difference between the two scoring systems is that they have different scales in regards to what’s considered “good” credit. For the most part, higher is better. We are now going to explore what goes into determining your credit score and how much of an impact each category has.
Payment history accounts for 35% of a person’s credit score. 35% is the largest contribution of any single factor of your credit history, making it paramount to have a good payment history when it comes to your lines of credit, whether it’s a small credit card or a large mortgage.
Lenders and creditors look at payment histories as a way to predict behavior in potential customers. Any late payment on any account will stay on someone’s credit report for 7 to 10 years. That means a college student struggling to pay for small things here and there may have trouble getting a car far after they graduate and have secured a steady job.
Someone who makes frequent payments on time and shows responsible behavior will earn favor and praise with the credit bureaus. A long line of credit with an excellent payment history will significantly increase the FICO or VantageScore.
The amount of debt in someone’s credit report is the second biggest factor when it comes to determining a credit score. Creditors want to avoid people that may not pay them back, so they measure a customer’s liability on whether or not they are paying back their debt or if they just keep accumulating more.
Lenders are in the business of lending (not giving) money to people, and they hope to make that money back plus interest. But there are people out there who may take the creditor for a ride and never pay back what they owe. A way to counteract bad financial actors is to measure the customer’s ability to pay the money back, which is why it is part of your credit score.
A good rule of thumb is to never utilize more than 30% of the available credit on any line of revolving credit e.g., if someone has a credit card with a limit of $10,000, they should keep it under 30%, which would be $3,000. It’s okay to have a little debt on a credit card if that debt limit is under 30%.
How long a customer has been using a line of credit, whether a revolving account or installment account, factors into the history and score as well. Unfortunately, this part of one’s credit score may discriminate against younger people as they don’t have the chance to build a credit history.
Creditors want to know that the person has been fiscally responsible for a long time to reduce risk for themselves. It’s riskier for a lender to give a line of credit to someone who does not have a track record of using lines of credit responsibly.
A credit card that’s been open for five to ten years with good payment history will contribute towards having a higher credit score. It shows that person has shown trustworthiness over a long period.
For those that do not have a long credit history, most credit card companies will allow people to open a secured credit card. The difference between this and a regular credit card is that it requires a deposit to open it, but it’s a great way to start building credit.
This is pretty straightforward as any type of new credit will affect this part of your credit score. This means any new revolving credit account or installment loan will negatively affect the score; however, the longer the account lasts, the more the score will improve.
This helps prevent people from opening a lot of credit cards at the same time.
The last thing that determines a credit score is how many different lines of credit the borrower has opened in the past and currently has open now. It’s important to have different types of credit cards from different companies, have different types of loans (student, car, mortgage, etc), and even other miscellaneous types of accounts appearing on a credit report.
Miscellaneous things can include one-off loans (like LOANME or AFFIRM) and other things like rent payments or utilities as well; however, it’s up to the customer to report these things to the bureaus themselves. One way to do this is to go through the Experian website and have them report utility bill payments. There are also third-party companies out there that can report rent payments, but this only helps if the payments are on time.
With these five factors in mind, it’s important to figure out how to improve credit scores. To recap, having multiple, diverse lines of credit with excellent payment history will have a positive impact on credit score.
However, it can be a daunting task to keep track of these things, learn new financial terms, go through your credit history, and understand what’s what. Professional consultants at Get Good Credit will help you with any sort of problem you may have with your credit report. You can call them at (877) 212-2450 for a free consultation at no risk.
If you have any questions, feel free to give us a call at 877-212-2450!
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