The importance of a credit score cannot be overstated. It is an essential part of personal finance, and knowing how it is calculated can help you make better financial decisions. After all, your credit score is a three-digit number that reflects your financial history and is used to determine your creditworthiness.
It can affect the interest rate you get on loans, the amount of money you can borrow, and even whether or not you are approved for a loan. A good credit score can help you get the best terms on loans and credit cards and make it easier to qualify for important purchases.
How Credit Score is Calculated?
But what exactly goes into calculating your credit score? Here’s a breakdown of how credit scores are calculated:
Payment History
This is the single most important factor in calculating your credit score. It accounts for approximately 35% of your total score and takes into account how often you pay your bills on time. Late payments, collections, and other delinquencies can have a significant impact on your score.
Credit Utilization
This accounts for 30% of your total score and looks at the amount of available credit that you use. A low utilization rate is considered favorable and indicates that you are using a relatively small amount of your available credit. The goal should be to keep your utilization rate below 30%.
Length of Credit History
This accounts for around 15% of your total score and looks at the age of your oldest account as well as the average age of all accounts. The longer that you have had active accounts in good standing, the better it will be for your score.
Credit Mix
This element takes into account the types of accounts that you have (credit cards, auto loans, personal loans, etc.). It accounts for 10% of your total score and having a mix of different types of accounts can help to boost it.
New Credit
This factor accounts for 10% of your total score and looks at how many new accounts you have opened in recent months. A high number can be seen as a red flag by lenders and could cause your score to drop.
Your credit score is determined by the above five factors, but it’s important to note that there are other factors that can also influence it such as your income, employment history, and whether or not you have applied for new loans or credit cards in a short period of time. Additionally, certain activities such as having a bankruptcy or foreclosure on your record can have an even bigger negative impact on your score.
By understanding how credit scores are calculated, you will be able to make more informed financial decisions that can help improve your credit score over time. Paying off debts on time, keeping utilization rates low, and avoiding opening too many new accounts can all have a positive impact on your score. With some patience and effort, you can improve your credit score and be in a better financial position.