Your credit score is one of the most critical factors of your creditworthiness. It is a three-digit number, ranging between 300-850, based on the metrics provided by the Fair Isaac Corporation. The higher your score is, the less risky you are to lenders. So how is credit score calculated?
What is the purpose of a credit score?
Before we go down this rabbit hole, let’s read a little about why lenders care profoundly about credit scores and how credit scores are calculated.
Spoiler Alert: It’s all about the money.
A credit score helps lenders and credit card issuers predict risk, which is the risk of loaning money. Credit score also answers some questions lenders might have, like, “If I let this person borrow money from me, how likely is he to pay it back as promised?”
The FICO score, used by 90% of top lenders in the United States, uses the information available on your credit report and predicts how likely you are to pay a bill 90 days late (or worse) within the next 24 months.
How is Credit Score calculated?
A good credit score gives you the leverage while applying for a loan since it assures the lender of your creditworthiness. A credit score typically ranges between 300 and 900, with 900 being the highest score possible. Major credit bureaus will consider your past credit history and repayment behavior and provide a comprehensive report to lenders.
Typically, a score of 750 and above is considered ideal to have your loan application approved by lenders, especially banks. Some of the factors that are taken into account while calculating your credit score are:
- Your repayment history
- Your credit utilization ratio
- Number of credit accounts
- Age/duration of your credit line
- Number of credit inquiries made by you
What factors make up your credit score?
For each category mentioned above, the scoring model will ask some questions, known as variables, that determine your score. You get your credit score when the scoring software adds all those points together.
Factors affecting your credit score
Some of the factors that affect your credit score are:
- Repayment history
- Credit utilization ratio
- Number of credit inquiries
- Length of credit history
- Credit mix
Payment history
How you pay your bill makes up for most of your score. While on-time payments won’t earn you the perfect 850 score, it is a great place to start. You get your credit score when the scoring software adds all those points together.
Amounts owed
If you own any Credit Cards, keeping your credit utilization ratio low might help you keep your score high. It is always a good idea to pay off your Credit Card bills on time since it is suitable for your credit score and bank account.
Length of credit history
Your credit score is also determined based on the length of your credit history, which makes up 15% of your credit score. If you have older credit accounts, the average age of those accounts may help you to earn more points for your overall credit score.
New credit and its effect on credit score
You might have heard that checking your credit report might hurt your credit score. While it is true, there are exceptions too. Ten percent of your credit score is your new credit in your account. When you apply for new credit, a lender checks a copy of your credit report, known as a hard inquiry. Hard inquiries appear on your credit report for 24 months. Some hard inquiries may hurt your credit score for up to 12 months, but others may be ignored.
Credit mix and its effect on your credit score
Credit mix is the final category that makes up for your 10% credit score, and diversity in this category will help your chances of increasing your credit score.
Despite what many others might believe, you don’t have just one credit score. You can keep track of all three credit reports and review them often. But trying to keep up with dozens of credit scores is tedious. While checking your report, pay special attention to payment history and credit utilization.
Finally, if you find any discrepancies in the report, you can dispute them. Ultimately, the best way to improve credit score is to use loans and Credit Cards responsibly and make timely payments. The more your credit history shows you handle credit responsibly, the lenders will be more willing to offer you credit with better rates.
How to improve your credit score?
To increase or improve your credit score, you need to address factors that are lowering your credit score. You can start doing this by reviewing your credit reports and ensuring there aren't any errors. Ensure you are updated on your payments and keep paying your cards on time. Finally, look at credit utilization once you're on time with all your minimum payments.
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