A credit score is a three-digit number that ranges from 300 to 850 and is used to determine your credit risk, or how likely you are to make on-time payments on your debts. When deciding whether to approve you for a new account, creditors and lenders consider a variety of factors, including your credit scores. Your credit scores may also have an impact on the interest rate and other conditions of any loan or other credit account for which you are qualified.
What Affects Your Credit Scores?
Our credit scores are determined by a number of factors, such as how long you’ve had credit and whether you pay your bills on time. Knowing the factors that affect credit scores will help you build or protect your credit in the most effective way possible. Your credit scores are calculated by credit scoring companies using data from your credit reports. They will not reveal their precise formulas, only the basic elements they use to calculate scores. Why is it important? Because your credit score frequently determines other aspects of your life, such as whether you can get a credit card or car loan and at what interest rate, whether you can buy a home or rent the apartment you want, and even how much you must pay for utility deposits and car insurance. Do you feel like you need an advanced degree to figure out what is affecting your credit score? The good news is you don’t—it can actually be rather simple.
Credit scores are calculated using five main variables. These scores are frequently used as the deciding factor in whether or not you are approved for a new loan because lenders use them to determine how likely you are to repay your debt. Knowing what elements and types of accounts have an impact on your credit score gives you the chance to raise it over time as your financial profile evolves.
Top 5 Credit Score Factors
While the exact criteria used by each scoring model varies, here are the most common factors that affect your credit scores.
- Payment history: The most crucial component of credit scoring is payment history, and even one late payment can lower your score. When considering you for new credit, lenders want to be certain that you will repay your debts on time.
- Amounts owed: The next most significant factor in determining your credit scores is your use of credit, particularly as shown by your credit utilization ratio. By dividing the total amount of revolving credit you are currently using by the sum of all of your revolving credit limits, you can determine your credit utilization ratio. This ratio measures how much of your available credit you are using and can provide an overview of your dependence on non-cash resources.
- Credit history length: How long you’ve held credit accounts? This includes the average age of all your accounts as well as the ages of your oldest and newest credit accounts. Your credit scores will typically increase with the length of your credit history.
- Credit mix: People with top credit scores often carry a diverse portfolio of credit accounts, which might include a car loan, credit card, student loan, mortgage, or other credit products. The types of accounts you have and how many of each you have are taken into account by credit scoring models as a sign of how well you handle a variety of credit products.
- New credit: The number of credit accounts you’ve recently opened, as well as the number of hard inquiries lenders, make when you apply for credit, accounts also on your credit score. Too many accounts or inquiries can indicate increased risk, and as such can hurt your credit score.
Types of Accounts That Impact Credit Scores
There are generally 3 types of credit accounts that can impact your credit scores: revolving, open, and installment. Because revolving and installment accounts keep a record of your debt and payment history, they are important for calculating your credit scores.
1. Installment credit usually comprises loans where you borrow a fixed amount and agree to make a monthly payment toward the overall balance until the loan is paid off. Student loans, personal loans, and mortgages are examples of installment accounts.
2. Revolving credit is typically associated with credit cards but can also include some types of home equity loans. With revolving credit accounts, you have a credit limit and make at least minimum monthly payments according to how much credit you use. Revolving credit can fluctuate and doesn’t typically have a fixed term.
What Impact Does Having Multiple Accounts Have on My Credit Score?
One of the most popular factors used to determine your credit scores is the credit mix or the variety of your credit accounts. Additionally, consumers tend to overlook it the most. Maintaining multiple credit accounts, such as a mortgage, personal loan, and credit card demonstrate to lenders your ability to balance multiple types of debt. It also makes it easier for them to understand your financial situation and capacity for debt repayment. Less variety in your credit portfolio won’t necessarily lower your scores, but the more credit types you have, as long as you pay your bills on time, the better.
What Can Hurt Your Credit Scores
Less variety in your credit portfolio won’t necessarily lower your scores, but the more credit types you have, as long as you pay your bills on time, the better.
- Missing payments. Payment history is one of the most important aspects of your credit score, and even one 30-day late payment or missed payment can have a negative impact.
- Using too much available credit. High credit utilization can be a red flag to creditors that you’re too dependent on credit. Credit utilization is calculated by dividing the total amount of revolving credit you are currently using by the total of all your credit limits.
- Applying for a lot of credit in a short time. Each time a lender requests your credit reports for a lending decision, a hard inquiry is recorded in your credit file. These inquiries stay in your file for two years and can cause your score to go down slightly for a period of time. Lenders look at the number of hard inquiries to gauge how much new credit you are requesting. Too many inquiries in a short period of time can signal that you are in a dire financial situation or you are being denied new credit.
- Defaulting on accounts. The types of negative account information that can show up on your credit report include foreclosure, bankruptcy, repossession, charge-offs, and settled accounts. Each of these can severely hurt your credit for years, even up to a decade.
How to Improve Your Credit Score
Improving your credit score can be easy once you understand why it is struggling. It may take time and effort, but developing responsible habits now can help you improve your score in the long run.
A good first step is to get a free copy of your credit report and score so you can understand what is in your credit file. Next, focus on what is bringing your score down and work toward improving these areas.
Here are some common steps you can take to increase your credit score.
- Pay your bills on time: Because payment history is the most important factor in making up your credit score, paying all your bills on time every month is critical to improving your credit.
- Pay down debt: Reducing your credit card balances is a great way to lower your credit utilization ratio, and can be one of the quickest ways to see a credit score boost.
- Make any outstanding payments: If you have any payments that are past due, bringing them up to date may save your credit score from taking an even bigger hit.
- Dispute inaccurate information on your report: Mistakes happen, and your scores could suffer because of inaccurate information in your credit file. Periodically, monitor your credit reports to make sure no inaccurate information appears. If you find something that’s out of place, initiate a dispute as soon as possible.
- Limit new credit requests: Limiting the number of times you ask for new credit will reduce the number of hard inquiries in your credit file. Hard inquiries stay on your credit report for two years, though their impact on your scores fades over time.
What to Do if You Don’t Have a Credit Score
If you want to establish and build your credit but don’t have a credit score, these options will help you get started.
- Get a secured credit card: A secured credit card can be used the same way as a conventional credit card. The only difference is that a security deposit typically equal to your credit limit is required when signing up for a secured card. This security deposit helps protect the credit issuer if you default and makes them more comfortable taking on riskier borrowers. Use the secured card to make small essential purchases and be sure to pay your bill in full and on time each month to help establish and build your credit.
- Become an authorized user: If you are close to someone who has a credit card, you could ask them to add you as an authorized user to jump-start your credit. In this scenario, you get your own card and are given spending privileges on the main cardholder’s account. In many cases, credit card issuers report authorized users to the credit bureaus, which adds to your credit file. As long as the primary cardholder makes all their payments on time, you should benefit.
Are you ready to improve your credit score? Tax Plus Financial Services will help you repair your credit, making your personal life much easier!