A credit score can be compared to grades in school. Teachers calculate grades by taking scores from different things, like homework, tests, attendance etc. They all weigh a different percentage in your grade. The credit score is similar. There are different factors to calculate your score and they weigh a different percentage.
There are three major credit bureaus: Equifax, Experian and Transunion, they all worked with Fair Isaac to come up with a score. The credit score numbers range from 300 to 850. The following is a breakdown of how the credit score is determined:
- 35 percent is based on credit history. Lenders like to see if you pay on time or not. If you have late payments and collections that can affect negatively your score.
- 30 percent is based on outstanding debt. How much debt do you have? Any car payments, student loans, mortgage? How many credit cards you have with high balances? The best idea is to keep your credit cards utilization at 25 percent of usage of their limit.
- 15 percent is the length of credit. The longer you had established your credit the better for your score. One mistake that I made was having a credit card and not using it. I have a credit card for over 12 years and my credit history is only 3 years. I didn’t use my cards for some time. If lenders see payment history for a long time they will use that to predict your actions in the future.
- 10 percent is based on new credit. New credit accounts can affect your score for some time. Hard inquires stay in your credit for 2 years. Soft inquires do not affect your credit score.
- 10 percent is based on the different types of credit you have. This will show that you can handle different types of credit accounts. I have 2mortgages, personal loan, student loan, several credit cards and a store card. They show that I can pay responsibly with different kinds of credits.
The information to determine the score is compared with the information of other consumers with similar profiles. Sometimes, some lenders have their own scoring methods, that can be based on income or length on the job.
How did this 3-digit number affect me and how important is it for interest rates?
If you have a low credit score you can end up paying a lot more than people with better scores. Your score can get in the way of getting a car, a house, or your score will significantly affect your chances of getting a good interest rate on a loan. When your score is low, you are considered to have a higher risk for lenders. This means that your interest rate will be higher and your monthly payments can significantly increase. However, if you have a higher score, your interest rates will be lower. There are others factors that can influence the score and sometimes is not the score alone. Sometimes lenders will add many fees that can affect your monthly payment.
Rates on your insurance are often determined by your credit score. You will think that your driving record have little to do with your credit. However, they can predict that more claims will be filed if your score is low.
A common practice that consumers hate is credit card companies and their policies. As I mentioned earlier, your score can affect your interest rate when it comes to credit cards, your interest can change any time. Even if you pay on time, your credit card can default on a separate loan and your credit card can raise your rate drastically.
As an important investment, learn and improve your credit score. Having a good credit score will save lots of money on the long run.