Credit scores are numerical representations of your creditworthiness, which lenders use to determine how risky it might be to lend you money or offer you credit. The score ranges from 300 to 850, with higher scores indicating better creditworthiness. Here’s how they work and the factors that go into calculating them:
1. Payment History (35%)
This is the most important factor. It looks at whether you’ve made your credit card, loan, and mortgage payments on time. Missed or late payments can significantly hurt your score. Bankruptcy, collections, or other serious payment delinquencies also lower your score.
2. Credit Utilization (30%)
This is the ratio of your credit card balances to your credit limits. It’s calculated by dividing your total credit card debt by your total credit limit. The lower the ratio, the better it is for your score. A high utilization ratio (e.g., using 80% of your available credit) can hurt your score because it suggests you’re over-relying on credit.
3. Length of Credit History (15%)
A longer credit history is generally better because it shows that you have experience managing credit. The age of your oldest account, the average age of all your accounts, and the age of specific types of accounts (credit cards, loans, etc.) all contribute.
4. Types of Credit Used (10%)
Lenders like to see that you can manage different types of credit (credit cards, mortgages, installment loans, etc.). Having a mix of different credit accounts can be beneficial, but it’s not necessary to have all types. Opening too many new accounts just to improve this factor could hurt your score.
5. New Credit Inquiries (10%)
When you apply for new credit, a “hard inquiry” is made on your credit report. While one or two inquiries won’t hurt your score much, several in a short period can indicate that you’re taking on too much debt, which can lower your score. However, soft inquiries (like checking your own credit or getting pre-approved offers) don’t impact your score.
Credit Score Ranges:
• 300-579: Poor – Lenders see you as a high-risk borrower.
• 580-669: Fair – You may be approved for credit, but at higher interest rates.
• 670-739: Good – You have a solid credit history and can get credit with competitive terms.
• 740-799: Very Good – Lenders trust you and offer low interest rates.
• 800-850: Excellent – You have a long, positive credit history and can get the best rates and offers.
How to Improve Your Credit Score:
• Pay your bills on time, every time.
• Keep your credit utilization low.
• Avoid opening too many new accounts at once.
• Keep old accounts open to build a longer credit history.
• Check your credit report regularly for errors.
Credit scores are used in many financial decisions, from applying for loans to renting an apartment. Building and maintaining good credit is important for accessing favorable financial products.
