A Credit Score is a three digit number but this seemingly harmless number is strongly tied to the amount you can borrow. It also influences the terms of borrowing. In order to stay on top of your finances, it is crucial for an individual to thoroughly understand credit scoring in order to make well-informed decisions.
Credit Scores: How Credit Bureaus Calculate Them
There are three main credit bureaus operating in United States, Equifax, Trans Union and Experian. While every credit bureau uses a different method for calculating the credit score, individuals with a long history of paying their debts on time, using the appropriate types of credit and not exceeding their available credit lines are most likely to have a good credit score. The ideal credit score falls in the range of 300 to 850. The higher your credit score, the higher are your chances of securing a loan with desirable terms.
While there are several credit scoring companies, the FICO score is the most widely used in mortgage application. Several factors contributing to the FICO score are as follows:
As the highest contributor to your score, individuals with a habit of paying bills late are most likely to suffer. Since payment history is a clear reflection of an individual's likelihood of committing default on financial obligations, it is the biggest contributor in a credit score calculation at a 35% value.
The next biggest contributor to your credit score is the amount you owe. If the amount of debt you owe is close to your credit limit, your score will take a steep decline. Similarly, if you have outstanding balance on several accounts, this reflects negatively on your credit score. Outstanding debt has a 30% value on the score. This factor also takes into account the amount of debt you owe as compared to the amount of the amount of debt available.
Length of credit history
The next most crucial aspect of your credit score is the length of credit history. They say old credit is the best credit. This is indeed true because the longer your accounts are open, the better it is with boosting your score. Length of credit history has a 15% contribution to the credit score. The length of credit history is further broken down into three parts which is how long certain account types have been opened, how long accounts have been opened, and how long since those accounts have been used. At least one credit account that is active in the last six months is crucial for a long and well established credit history.
If you have applied for any new credit accounts recently, it will calculate a 10% value towards your credit score. If you have opened several accounts in a small time frame, your credit score will decrease. This can be particularly dangerous if an individual does not have a very long credit history.
Types of credit
This is where the types of credit you have come into play. Finance company accounts, retail accounts, installment loans, and credit cards accounts are the ideal scenario for a healthy mix of installment and revolving accounts. This aspect is usually taken into consideration only when there isn't sufficient information to determine the score.
What is worse for your credit scores?
Are you wondering what is worse for credit scores? Bankruptcy, foreclosure, collection and charged off accounts? Whether it's a foreclosure on your report, bankruptcy or charged off accounts, the credit score is going to drop. All three scenarios show a pattern of not being able to fulfill your financial obligation and will obviously lower your score.
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