What is a credit score?
Your credit score is a number that represents how likely you are to pay back money that you borrow. This number is important because it affects whether or not banks, credit card companies, and other lenders will give you a loan or let you open a credit card account. It can also affect the interest rates you're offered, which can make borrowing more expensive if your credit score is low.
Key Takeaways
A credit score is a number that represents how likely you are to pay back money that you borrow.
Your credit score is based on factors like whether you've paid your bills on time, how much debt you owe, and how long you've had credit.
A good credit score can make it easier to get loans and credit cards with lower interest rates, while a poor credit score can make it harder to get approved for credit and may result in higher interest rates.
To improve your credit score, you should pay your bills on time, keep your credit card balances low, and avoid applying for too much credit at once.
You should also check your credit report regularly to make sure there aren't any errors that could be bringing your score down.
Different credit bureaus may calculate your credit score differently, so it's a good idea to check your score from multiple sources.
There are different types of credit scores, but FICO scores and VantageScores are the most commonly used by lenders.
A good credit score ranges from 670 to 850, but the specific score you need will depend on the lender and the type of credit you're applying for.
Your credit score can change over time based on your credit activity, so it's important to keep monitoring it regularly.
Your credit score is calculated based on a few factors, such as whether you've paid your bills on time, how much debt you owe, and how long you've had credit. These factors are used to determine how risky it is to lend you money.
If you have a good credit score, it means you're seen as a responsible borrower and lenders are more likely to give you loans and credit cards with lower interest rates. On the other hand, if you have a poor credit score, it means you're seen as a risky borrower and lenders may charge you higher interest rates or reject your application altogether.
Improving your credit score is important because it can make borrowing cheaper and easier in the future. You can improve your credit score by paying your bills on time, keeping your credit card balances low (or at zero), and not applying for too much credit at once. It's also important to check your credit report regularly to make sure there aren't any errors that could be bringing your score down.
Who calculates credit scores?
You may be wondering, who calculates your credit score, and how is it determined? The answer is that there are several credit bureaus or credit reporting agencies that collect information about your credit history and calculate your credit score based on that information.
The three major credit bureaus in the United States are Equifax, Experian, and TransUnion. These bureaus collect data on your credit accounts, such as credit cards, loans, and mortgages, as well as your payment history, outstanding balances, and credit inquiries.
Using this information, they calculate your credit score using a specific formula or algorithm that takes into account various factors like your payment history, credit utilization, length of credit history, and types of credit used.
Each bureau may have slightly different ways of calculating your score, but they generally use the same basic factors. The most commonly used credit scoring models are FICO scores and VantageScores, which are used by many lenders to determine your creditworthiness.
So, to sum it up, credit scores are calculated by credit bureaus based on information from your credit report, and different lenders may use different scoring models to determine your creditworthiness. It's important to keep an eye on your credit score and make sure the information in your credit report is accurate to ensure that you can get approved for credit and get the best possible interest rates.
What Factors Affect Your Credit Score: How Your Score Is Calculated
First, it's important to understand that your credit score is calculated based on information in your credit report, which we discussed above and is a record of your credit history typically reported on by Equifax, Experian, and TransUnion. Again, this report includes information about your credit accounts, such as credit cards, loans, and mortgages, as well as your payment history, outstanding balances, and credit inquiries.
So, what factors make up your credit score? There are several key factors that are generally used by credit scoring models, including:
Payment history (35%): This is the most important factor in determining your credit score. Lenders want to know if you have a history of paying your bills on time and in full.
One reported missed payment of 30 to 60 days is more easily recovered from, but this can still impact your score significantly.
One reported missed payment of 90 days or more can disqualify you for loans and damage your credit score for a longer period of time. Missed payments over 90 days are also able to be turned over to collection agencies.
Credit utilization (30%): This is the amount of credit you're using compared to the amount you have available. Lenders prefer to see that you're using a low percentage of your available credit. Your total available credit is the sum of all your credit limits, and your utilization ratio is the sum of all your balances divided by the sum of your total credit limit.
You do not need to carry any balances to build or improve your credit.
Individual card balances matter more, but the average across all credit accounts is important as well.
Less than 30% utilization is the general consensus on a target to aim for.
Closing of accounts reduces your total available credit and increases your utilization which typically leads to a lower score.
Length of credit history (15%): This is how long you've had credit accounts open. Lenders like to see a longer credit history, as it shows that you have a track record of managing credit responsibly.
Closing your oldest accounts can significantly lower your credit score in the short and mid term. Some credit accounts will automatically close your account if it is inactive for too long. You can use the account once in a while and pay it in full to keep it active.
Older accounts like student loans, car loans and mortgages will impact your score when they fall off, however, your score is likely to only decrease temporarily.
Types of credit used (10%): This includes credit cards, loans, and mortgages. Having a mix of different types of credit can be beneficial, as it shows that you can manage different types of debt.
Having a mix may be helpful, but not having a mix is not that impactful. Therefore, taking out different types of credit to try and enhance your credit score does not make sense.
Recent credit inquiries (10%): This refers to how often you've applied for credit. Multiple credit inquiries in a short period of time can negatively impact your credit score.
These are typically called “Hard Inquiries” and are temporary dings to your credit score.
Most scores recover in 90 days for inquiries.
If you know you are applying for a large loan (mortgage, vehicle…etc) then it would be wise to minimize your inquiries the preceding year.
Keep in mind that these percentages can vary slightly depending on the credit scoring model used. Each factor is weighted differently in the calculation of your credit score, and the specific scoring model used may vary. The most commonly used models are FICO scores and VantageScores, which range from 300 to 850.
If you want to improve your credit score, the most important thing you can do is make sure you're paying your bills on time and in full. You should also aim to keep your credit utilization low, and avoid opening too many new accounts at once. With time and responsible credit management, you can improve your credit score and open up more opportunities for borrowing at better rates.
What Information Credit Scores Do Not Consider
Now that we have discussed in detail what factors make up your credit score, it's important to know that credit scores don't take into account certain types of information.
First, credit scores don't consider your income or employment history. While having a steady income and employment history is important for being approved for a loan, it doesn't factor into your credit score.
Second, credit scores don't take into account your age, gender, race, religion, or marital status. These personal characteristics are protected by law and cannot be used as factors in credit scoring.
Third, credit scores don't consider your savings, investments, or assets. These factors may be important in determining your overall financial health, but they are not taken into account in credit scoring.
Lastly, credit scores don't factor in any criminal history you may have. While a criminal record may impact your ability to be approved for certain types of loans, it doesn't impact your credit score.
It's important to understand what credit scores do and do not consider so that you can take steps to improve your creditworthiness in areas that do matter. Building a good credit history by paying bills on time and keeping credit card balances low (preferably zero) is key to achieving a high credit score.
Why There Are Different Credit Scores
If you've ever applied for credit and received multiple credit scores, you may have noticed that they aren't all the same. This can be confusing and lead to questions about why there are different credit scores.
Credit scores can differ for a few reasons. Firs, there are different credit scoring models used by different credit reporting agencies. For example, one credit bureau may use the FICO® Score model, while another may use the VantageScore model.
Additionally, not all lenders report to all three major credit bureaus, which means that each bureau may have slightly different information on your credit report. This can also result in different credit scores.
Finally, each credit score is calculated using a different formula and weighting system, which means that even if the same credit score model is used, the results can still vary depending on the information included in the calculation.
Despite the differences, all credit scores are designed to measure your creditworthiness and the likelihood that you will pay back borrowed money on time.
In summary, different credit scores exist because there are multiple credit scoring models, not all lenders report to all three credit bureaus, and each credit score is calculated using a different formula and weighting system. Despite the differences, credit scores are important because they are used by lenders to determine your creditworthiness and can impact your ability to get approved for credit and the terms you receive.
You Can Get a Free Credit Score
If you're curious about your credit score, you may be surprised to learn that you can get it for free. Many credit monitoring services offer free credit score access, and you can even get your score from some credit card issuers and banks.
Here's how to get your credit score for free:
Check with your bank or credit card issuer: Many banks and credit card issuers offer free credit scores to their customers. Check with your financial institution to see if they offer this service.
Sign up for a credit monitoring service: Several websites offer free credit scores as part of their credit monitoring services. One of the most popular is Credit Karma (which I have used for several years as a good temperature check), which provides access to your TransUnion and Equifax credit scores for free. Another reputable website to get your free credit score is Credit Sesame. Credit Sesame offers free credit scores and credit monitoring. They also provide personalized recommendations to help you improve your credit score. Click on this link to sign up for Credit Sesame and get your free credit score today: https://www.creditsesame.com/
Use a credit score estimator: Some websites offer a credit score estimator that uses your credit report data to predict your credit score. While not as accurate as an actual credit score, it can give you an idea of where you stand.
Check with a credit counselor: Non-profit credit counseling agencies can provide free credit counseling and may be able to provide you with a free credit report and score.
Remember, your credit score is an important indicator of your financial health. Knowing your score can help you identify areas where you need to improve and can help you qualify for better interest rates and loan terms.
Conclusion
Having a good credit score is important for many aspects of your financial and personal life. It can impact your ability to get approved for loans, credit cards, and even employment and housing. By understanding how credit scores are calculated and taking steps to improve your score, you can set yourself up for financial success.
Remember to make on-time payments, keep your credit utilization low, and monitor your credit report regularly to ensure accuracy. With some effort and dedication, you can achieve and maintain a strong credit score, which can help you achieve your financial goals and enjoy peace of mind.
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