Lenders use this number to determine how much of a risk it is to let you borrow money. Many lenders, including credit card companies and automotive dealerships, check your score in order to determine how much they’re willing to lend you and how much interest they should charge you.
Now you’re wondering how your credit score is calculated and what numbers are taken into account. Here is a simple explanation of what affects your score and what it will mean when you apply for a loan.
Table of contents
35% – Payment History
Your payment dependability, and past, account for the largest chunk of your total credit score. This factor is calculated using a few elements, like whether you pay bills on time, how long payments were delayed by, if any accounts went to collections, and if you’ve experienced something like bankruptcy.
Depending on the how you’ve managed these factors your credit score can be positively affected or negatively. Since payment history is such a large portion of your total score it’s vital that you keep on top of these things and check in with your finances regularly.
30% – What you Owe
The second largest portion of your credit score takes your current debts into consideration. The concept here is that owing less is better and can make you more you a more enticing borrower to lenders if you are more likely to pay them back.
That being said, a lender wants to see that you are/have borrowed money and that you are both responsible and financially stable enough to make your payments. It’s a good sign that you will do the same with the money they lend you.
Finally, what percentage of your credit limit are you using? If the amount of credit you use is high in relation to the amount available to you, your score may be lowered. Paying off debts before they reach 35% of the total available seems to be the key to balancing your score.
15% – Credit History Length
This is a measurement of how long you have been using credit. The length of time you have been using credit, the age of your oldest account and what the average of all the accounts are is used to calculate this factor of your score.
As long as regular and timely payments have been made on all accounts a lengthy history is not a bad thing. It will show lenders that you are reliable and that they will get their investment back. Unfortunately, for people with little to no credit history this aspect can lower their total score. In that case, creditors won’t have enough evidence as to whether or not the borrower will their make payments.
10% – New Credit
How many accounts have you applied to open recently? When was the last time that you opened a new account? If you have recently opened a few new accounts a creditor or lender might assume that you are struggling to pay back your debts and are taking addition credit to pay them down.
This will reflect negatively on your credit score, while opening new accounts at wise times can be a positive boost. Just be aware that while lenders can’t base their decision on what to lend you based on guessing what you may do, but they will use you score to gauge how much of a potential risk are.
10% – Types of Credit
Lastly, the types of credit you have, like store financing, car loan or mortgage, credit card, etc… is taken into consideration. This also includes how much you owe for each account.
A diverse variety of credits type can actually be beneficial as it establishes how capable you are of managing debt. Therefore, if you are handling them effectively your score will reflect positively, and vice versa.
These are the most influential factors that go into calculating your credit score. The way it’s calculated depends on the credit bureau; Equifax or TransUnion if you’re in Canada. Which means that it’s up to individual lenders to interpret the details for themselves.
As long as you are aware of and understand these factors you will be equipped to successfully manage your credit.
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