How Is My Credit Score Calculated: Crucial Factors Explained
A credit score is a three-digit number that represents your creditworthiness, typically ranging between 300 and 850. It helps financial institutions determine your eligibility for loans, credit cards, and other financial products, as well as the interest rates you receive. To understand how your credit score is calculated, it’s important to know the key factors that influence it.
Fun Fact: Did you know that the average age of your open credit accounts can impact your credit score? Lenders like to see a long history of responsible credit use, so closing your oldest credit card could actually lower your score!
The most commonly used credit scoring model is the FICO score. It is made up of the following factors:
| Year | Interest Calculation |
|---|---|
| Payment history (35%) | Your record of on-time payments, late payments, and the length of time since your last late payment. |
| Amounts owed (30%) | The total debt you carry, including credit card balances, loans, and outstanding bills, in relation to your maximum available credit. |
| Length of credit history (15%) | The age of your oldest and newest credit accounts, as well as the average age of all your accounts. |
| Credit mix (10%) | The variety of credit accounts you have, including credit cards, loans, and lines of credit. |
| New credit (10%) | The number of recent credit inquiries or new lines of credit you have opened. |
Each of these factors contributes to your overall credit score, with payment history and amounts owed having the most significant impact. To maintain a healthy credit score, it’s essential to consistently make on-time payments, keep your credit utilization rate low, avoid opening too many new accounts at once, and maintain a diverse mix of credit types.
You can regularly monitor your credit score through free services like Credit Karma or by requesting a free report from each of the three major credit reporting agencies (Equifax, Experian, and TransUnion) once per year from AnnualCreditReport.com. This can help you identify areas for improvement and track your progress over time. Remember to correct any inaccuracies on your credit report to ensure it accurately reflects your credit history.
Treat your credit score as an ongoing priority throughout your financial life, as it can significantly affect your ability to achieve your financial goals. By understanding the factors that contribute to your credit score and taking the necessary steps to maintain or improve it, you will be better positioned to make sound financial decisions and achieve long-term success.
Different Factors that Influence Your Credit Score
Payment History
Your payment history has a significant impact on your credit score. Lenders want to know if you have consistently paid your bills on time. Late or missed payments can lower your credit score, while a record of timely payments can improve it. To maintain a good credit score, consistently pay your bills before their due dates.
Amount of Debt Owed
The amount of debt you owe, also called credit utilization, accounts for a large portion of your credit score calculation. Lenders will look at how much credit you are using compared to the total credit available to you – the lower the percentage, the better. Aim to keep your credit utilization ratio below 30% to maintain a healthy credit score.
Length of Credit History
The length of your credit history refers to how long you’ve been using credit. This includes the average age of your accounts and the age of your oldest account. A longer credit history typically results in a higher credit score, as it demonstrates your experience in managing credit. Maintaining older accounts and using them responsibly can benefit your credit score in the long run.
New Credit Accounts
Opening new credit accounts frequently can negatively impact your credit score. When you apply for new credit, a hard inquiry is placed on your credit report, which can lower your credit score temporarily. To avoid this, only apply for new credit when necessary and space out applications over time.
Types of Credit in Use
The types of credit in use, also known as credit mix, refer to the variety of credit accounts you have. This can include credit cards, loans, and mortgages. Lenders like to see a diverse mix of credit types, as it demonstrates your ability to manage different types of debt. While it is not necessary to have one of every type of credit, maintaining a healthy mix can positively affect your credit score.
Effect of Negative Factors on Credit Score
Late Payments
Your payment history has a significant impact on your credit score calculation. Missing or making late payments can negatively affect your credit score. The more frequent these incidents are, the worse the effect on your score. It’s important to make timely payments, as even a single payment that is 30 days late can cause significant harm to your credit score.
Bankruptcy
One of the most damaging financial events you can experience is filing for bankruptcy. It significantly lowers your credit score and remains on your credit report for up to 10 years. The impact of bankruptcy on your credit score will vary depending on your credit history, but it’s crucial to keep in mind that bankruptcy should be regarded as a last resort.
Foreclosures
Foreclosures can also have a negative effect on your credit score. A foreclosure occurs when a lender repossesses a property due to the borrower’s failure to keep up with mortgage payments. Similar to bankruptcy, a foreclosure can remain on your credit report for up to seven years. The foreclosure will lower your credit score, making it more difficult to obtain credit in the future.
Remember that understanding how your credit score is calculated, and being aware of the negative factors that can affect it, are instrumental in maintaining and improving your credit score. By keeping track of your credit history and working to mitigate any negative factors, you can work towards achieving and maintaining a higher credit score.
Best Practices to Maintain a Good Credit Score
Paying Bills on Time
One of the key factors in maintaining a good credit score is ensuring that you pay your bills on time. This includes not only your credit card bills but also other loans, utilities, and even cell phone bills. Late or missed payments can have a negative impact on your credit score. To help you stay organized and avoid late payments, consider setting up automatic payments or electronic reminders.
Keeping Balances Low
Another important aspect of maintaining a good credit score is keeping your credit card balances low. Experts suggest keeping your credit utilization ratio (the percentage of your available credit that you’re using) below 30%. This means if you have a credit limit of $10,000, try not to carry a balance of more than $3,000.
Keeping your balances low and paying them off each month shows lenders that you are responsible with your credit and reduces the chances of your credit score being negatively affected.
Limiting New Credit
While having a mix of credit accounts is good for your credit score, applying for too many new credit lines within a short period of time can raise a red flag for potential lenders. Every time you apply for credit, an inquiry is recorded on your credit report, which can lower your score.
It’s essential to pace yourself when opening new accounts and only apply for the credit you genuinely need. This will not only help you maintain a good credit score but also demonstrate responsible credit behavior.
In summary, by paying bills on time, keeping your balances low, and limiting the number of new credit applications, you can ensure a higher credit score. While calculating a credit score involves multiple factors, following these best practices will help you maintain or improve your creditworthiness in the eyes of lenders.
