Consumers must know their credit score if they wish to have an accurate picture of their current financial situation when they are applying for credit cards or another loan. This number provides information about the consumer and their ability to pay debts in a timely manner. Think of the credit score as a risk score. Lenders look at this number when determining whether to provide funds to an individual. A high score means they will take on less risk and they are more likely to approve the application. A low score suggests they will take on more risk, and they charge the consumer more to account for this increased risk.
Types of Credit
When you go to learn more about your credit score, recognize there are different credit scores calculated today. Each scoring system used produces a unique score, and several credit bureaus now provide these scores. As a result, consumers find their credit score may vary by the company providing the score, although they fall within a certain range. A person won’t have poor credit with one company and outstanding credit with another. What factors influence this score?
Factors That Influence a Consumer’s Credit Score
Credit reporting agencies look at several factors when calculating a consumer’s credit score. Payment history and credit utilization ratio come into play along with the age of the person’s credit history. The different types of credit impact the consumer’s credit score, as does the number of credit inquiries. Each category comes with its own weight, which consumers must understand.
Payment History
Lenders want to know whether a person pays their bills as agreed, which is why a person’s payment history accounts for 35 percent of the FICO score. Other credit reporting agencies also give this component more weight. Men and women find they spend years building up a good payment history. When late payments appear on the credit report, it takes time to repair this damage. For this reason, people must strive to pay all of their bills on time.
Credit bureaus only use information provided to them by lenders when calculating a credit score. When a lender or company doesn’t provide this information, the agency doesn’t factor it into the score calculation. Most credit card companies and loan providers report to the credit bureaus, but this isn’t the case with other bills. Credit bureaus are working to change this and incorporate more payments into a person’s credit score. This includes rent and utilities, among other things.
Credit Utilization
Next, credit reporting agencies look at a person’s available credit and how much of this credit they are using. This takes into account credit card balances when compared to all available credit. A person with $10,000 in credit and a balance of $2,000 has a credit utilization ratio of 20 percent.
Aim for low credit utilization to improve the credit score. Credit reporting agencies determine how much is acceptable for this amount, and it serves as a sliding scale more than a set number. For instance, a 30 percent credit utilization ratio is better than 40 percent. However, most financial experts state a person should aim to keep their credit utilization below 30 percent. Other experts state they should never allow this number to go to zero. They feel lenders will hesitate to lend to this person because they could take out a loan and then go max out the credit they already had and get into trouble. This factor accounts for 30 percent of the person’s FICO score.
Credit History
Credit reporting agencies want to see an established credit history when evaluating a consumer. They look at several factors, which may include the age of each credit account and the average age of all accounts when combined. They look to see when the person last open an account and how long the person has been using each credit account. A person with a limited credit history hasn’t established a track record in paying bills, and the credit reporting agencies factor this in when calculating their score. Older accounts boost a person’s credit score, and the credit history makes up 15 percent of the consumer’s FICO score.
Diversity
The diversity of a person’s credit accounts impacts their credit score. Credit reporting agencies want to see a variety of accounts, such as a mortgage, auto loan, and credit card. This provides them with more information regarding how the person manages different types of credit as opposed to one. A person should never borrow money to boost the credit score, so don’t rush out and get an auto loan if you don’t already have one. The credit mix makes up only 10 percent of the FICO score, and consumers find they can get a high score even with nothing more than credit cards.
Credit Inquires
When a person applies for a credit account, an inquiry appears on the credit report. This shows a creditor looked at the person’s credit file. While this doesn’t have a significant impact on the credit score, multiple inquiries in a short period have a negative impact. Nevertheless, credit reporting agencies consider multiple inquiries from a single category of provider as one inquiry. For instance, when a person shops for a mortgage, they often put applications in with multiple lenders to find the best deal. The credit reporting agencies consider these inquiries as a single one. New credit inquires only account for 10 percent of the FICO score.
Individuals must monitor their credit score. Many companies look at this score when determining whether to work with a borrower, including housing providers, utility companies, and insurers. A good score helps a consumer save money, as higher scores typically translate to lower rates. An excellent credit score could lead to a borrower saving more than $100,000 on their home mortgage when compared to someone with a fair credit score.
The same holds true when a person goes to get a new vehicle. A person with excellent credit might qualify for zero percent financing, while a person with bad credit may pay 10 percent interest or more. This adds to the cost of the vehicle, something most people can no longer live without. Furthermore, a good score means more credit card options and lower car insurance rates. Establish good credit and work to keep it in great shape. Doing so benefits you in a variety of ways.