Credit scores play a crucial role in determining your creditworthiness when applying for loans or credit cards. Understanding how these scores are calculated and what factors influence them is essential for managing your financial health.
The two primary credit scoring models are FICO and VantageScore. FICO scores have been in use since 1989, while VantageScores, introduced in 2006, are developed by credit bureaus Experian, Equifax, and TransUnion.
Both FICO Score 8 and VantageScore 3.0 are the most commonly used editions, each analyzing various data inputs to assess your financial history.
Here’s a breakdown of the key factors that impact your credit score:
Payment history (35%)
Timely payments are crucial for maintaining a good credit score. Late payments can negatively affect your score and may remain on your credit report for up to seven years.
Amounts owed (30%)
This factor considers the total amount you owe across all credit accounts and your credit utilization ratio—the percentage of available credit you’re using. Keeping credit utilization below 30% is advisable.
Credit history length (15%)
The length of your credit history, including the age of your accounts, influences your score. Closing older accounts can impact your credit score, so it’s often beneficial to keep them open.
New credit applications (10%)
Applying for new credit can temporarily lower your score, especially if multiple applications are made within a short period. However, rate shopping for specific types of loans (e.g., mortgages or auto loans) within a short timeframe is usually treated as a single inquiry.
Credit mix (10%)
Lenders like to see a mix of credit types, including installment loans (e.g., mortgages) and revolving credit (e.g., credit cards). Maintaining a diverse credit portfolio can positively impact your score.
Improving your credit score involves various strategies tailored to your specific financial situation:
- Make timely payments: Set reminders to ensure all payments are made on time.
- Maintain a low credit utilization ratio: Aim to keep credit card balances low relative to your credit limits.
- Avoid frequent account openings and closures: Closing accounts can affect your credit history length, so think carefully before making changes.
- Regularly check your credit report: Monitoring your credit report allows you to identify errors or potential issues early.
Credit scores can change whenever new information is reported to credit bureaus by lenders. Understanding the credit score ranges—from poor to excellent—helps gauge your financial standing.
Remember that credit scores may vary between bureaus due to differences in reporting and scoring models. Regularly reviewing your credit report and scores can help you stay informed and make informed financial decisions.
