What is a Credit Score?
A credit score is a number used by lenders to assess the risk of lending money to someone. Borrowers with higher credit scores are less likely to default on loans. The higher your credit score, the more responsible you are as a borrower.
How are Credit Scores Calculated?
Credit scores are created by inputting your credit report data into a program that analyzes it. The program then generates a number. The three credit bureaus do not always use the same programs, so don’t be surprised if the credit scores they generate for you are not identical.
Key Numbers
The chart shown above details the approximate value each aspect of your credit report adds to your score:
- Payment history: 35%
- Amounts owed (credit utilization ratio): 30%
- Length of credit history: 15%
- Types of credit used (credit mix): 10%
- New credit: 10%
Payment History
Your payment history includes the number of accounts you’ve had and how you’ve paid them. This category also covers any negative public records or collections lawsuits in your name. The information on late accounts will include the total amount due on items that are past due, how long you were late, and how long it has been since you paid any past due balances, if applicable.
Amounts Owed
The amounts owed on your credit accounts factor into your total loan balances. This includes the portion of your credit limits that you’re using compared to your total credit limits. If you have one credit card with a $5,000 limit and you’ve charged $2,500 that you haven’t paid off yet, this could be a sign that you are experiencing financial strain. This is referred to as your credit utilization ratio.
Length of Your Credit History
This category isn’t as important as the first two, but it is still significant. It shows how long you’ve had credit. The longer the better. This includes the total length of time tracked in your credit report, how long it has been since you opened your accounts, and how long it has been since your last activity.
Types of Credit
A mix of account types results in better outcomes than reports showing many revolving accounts, like credit cards. This signals to lenders that you don’t rely heavily on any one type of credit.
New Credit
The final category that affects your score is the amount of new credit that has been taken on recently. This considers the number of accounts you have opened relative to your total accounts. It includes the number of recent inquiries made on your credit report and/or score, as well as the time elapsed since the last inquiries were made or new accounts were opened.
What is a Good Credit Score?
Credit scores range from about 300 to 850. The higher your score, the lower the risk perceived by lenders. The interest rate offered to you often decreases as your score rises.
More financing options are available to borrowers with a credit score above 670. But don’t despair if your scores are low. There are financing products for nearly everyone.
According to a report from Experian, the average credit score in the U.S. reached a record high of 710 in 2020, and 69% of Americans had a “good” credit score above 670.
Improving Your Credit Score
Try to improve any of these areas on your credit report – especially the first two – if you’re considering applying for a loan to buy a home but don’t have the credit you’d like. Be patient. It takes time to build a strong credit history.
Source:
https://www.thebalancemoney.com/how-your-credit-score-is-calculated-1797900
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