Know How Your Score Works So You Can Improve Your Credit
In reality, we all get confused when it comes to our credit scores. Advertisements on T.V and radio announcements tell people that you only have three scores, which are all critical in determining whether you are going to get the best offer with your mortgage lender or auto loan provider.
But in actuality, you really have much more than three scores, as every lender, creditor and credit bureau has their own way of calculating your level of risk as a borrower. This is essentially what your credit score represents.
So, how do you know which aspects to improve on if you’re trying to increase your credit score?
Fact: Almost all credit score calculations are based on the formula used to calculate your FICO credit score.
What is a FICO Credit Score?
The term FICO stands for Fair Isaac and Company, the creators of the concept of a credit score. They invented this idea so that lenders and creditors can measure your creditworthiness and evaluate the risks of lending you money.
Your FICO score is a numerical value that lenders use to determine whether a person meets their standard of financial responsibility. It informs lenders about your financial stability and whether you will pay back what you owe reliably. The higher the score, the more likely you are to repay everything on time. Contrarily, a low score implies you are a high-risk borrower who may not repay their debt.
When Fair Isaac began calculating credit scores in 1956, they were the only company to do this. However, today there are three major credit bureaus in the U.S, including Equifax, Experian, and TransUnion. Other smaller credit reporting agencies and creditors around the world have their own, unique way of calculating your level of risk. All of these ways of calculating credit scores are different t, as they each represent a lender or company’s specific needs. Nevertheless, they’re almost all based on your FICO score.
So why focus on FICO?
If you understand your FICO credit score, then you should know how to improve your credit. All enhancements you make to your FICO score will affect your credit score positively as well, no matter which of the three bureaus you’re with. Understanding your FICO score is the first step in the right direction towards improving your overall credit.
How is a FICO credit score calculated?
Your credit score is calculated using multiple pieces of data taken from your credit report and grouped into 5 categories. Each of these factors has a certain level of significance attached to it, as the percentage taken from each section reflects the importance of that specific factor. Some factors affects your credit score a lot while others are not as important. The factors affecting your credit score are:
Payment History (35%)
Realistically, someone who has a consistent history of making payments on time is perceived as less risky and more trustworthy than someone who’s always late. Payment history is the most significant factor when calculating your FICO score, substantially impacting your credit rating. Thus, be timely with your bill payments, as it is necessary to have a positive payment history. .
Debt Owed (30%)
This factor considers the amount owed on all credit and loan accounts, which is ultimately your credit utilization ratio. It includes your total available credit relative to how much debt you owe in total. Reducing your outstanding debts is strongly advised, as we recommend keeping balances below 30% of your credit limit.
Length of Credit History (15%)
This category represents the length of all your accounts and how long you’ve been using credit for. A longer history is favorable, as someone with a more established and diversified credit history is seen as a less risky borrower. The longer you’ve used lines of credit, the better your overall credit score. Therefore, even if your not using old accounts, keep them open with zero balances,
New Credit (15%)
This includes the number new accounts you’ve recently opened and the amount of new accounts you’ve applied for lately. These are two factors creditors want to know about borrowers, as someone who recently opened multiple credit accounts is seen as high risk. The core assumption here is that if you’ve recently opened various new accounts, all your new obligations could put you at credit risk. Credit applications are considered “hard inquiries” and decrease your credit score each time you apply for credit. However, “soft inquiries” like checking your credit report, will have no effect on your credit score.
Types of Credit Used (10%)
The different types of credit used, such as credit cards, mortgages, store accounts and installment loans, how many accounts you currently have, and how often you use these different lines of credit are all considered when calculating your credit score. It is crucial to apply for credit in moderation, as your credit score slightly drops each time you apply for a loan or credit. Additionally, certain kinds of debt, like a mortgage or car loans, are advantageous for you and make you a more attractive borrower.
How to maintain a strong FICO credit score?
Your FICO credit score is between 300 and 850 points. According to Fair Isaac and Company, a good FICO score is 723, as they use the median credit score to predict what a good value is.
In order to maintain a good FICO credit score, consider the following tips:
- Your credit card balance should never be over 50% of your available credit limit. For instance, if your credit card limit is $10,000, you should never owe more than $5000 on that specific card.
- You should upkeep a balance of 10% to 15% of your available credit
- All payments made must be on time
- As hard inquiries can damage your credit score, even if you don’t end up opening the account, make sure not to consistently apply for new credit.
- Even if you’re not using old credit lines, keep the accounts open at a 0 balance
- Continue using credit on a daily basis in order to build a positive credit history
- Make sure to check your credit report annually and check for any mistakes
- If there are errors made on your credit report, call the company and fix it immediately.
If you’re working towards building and improving your credit score, ensure that your actions are working properly. If you’re having issues increasing your credit score, try credit monitoring services. This service will help monitor your credit until it is where you’d like it to be, and until you feel comfortable on your own.