Have you been wondering: “What is a good credit score?” Most people know that a good credit score can make it easier to get approved for loans, mortgages, and credit cards. But what remains confusing is how credit scores are calculated and what exactly is a good credit score. Understanding these two aspects is important so you can avoid inadvertent mistakes and focus on building good credit.
There are multiple credit scoring models and ranges may vary depending on which scoring model is used. In general, credit scores are indicated as a three-digit number ranging from 300 to 850.
Higher scores assure lenders that you are more likely to repay your future debts as agreed. This makes it easier for you to get approved for loans, mortgages and credit cards.
Your credit score is calculated using information in your credit report. There are five factors in particular that play a major role in calculating your score. Each of these factors accounts for a specific percentage of your total score:
Payment history has the biggest impact on your score. It makes up 35% of your total score. Making on-time payments consistently can help build your score slowly but surely. One missed payment may ding your score just a little bit. A history of late or missed payments will damage your credit score more than any other factor.
Credit utilization ratio is calculated as the amount of credit used divided by the total available credit limit. A high ratio means you’re using a high portion of your credit limit. This will hurt your score. A low ratio indicates the opposite and will help build your score. Credit utilization ratio accounts for 30% of your total score.
Length of credit history makes up 15% of your credit score. It includes the average age of all the credit accounts you hold, from the oldest to the newest. The longer the average age, the better for your credit standing. One way to help your credit age is by leaving your older accounts open.
Credit mix takes into account how many installment accounts and how many revolving accounts you hold. Installment accounts include all types of loans such as mortgages and student, personal, and vehicle loans. Revolving accounts include credit cards and other types of credit lines. Having both types of accounts and managing both responsibly can add as much as 10% to your credit score.
This takes into consideration whether you’ve recently applied for or opened a new credit account. This could be in the form of a new loan or a new credit card. When you apply for new credit, it triggers a hard inquiry, which hurts your score. Not applying for or taking on new credit can add up to 10% to your score.
Focusing on the underlying factors that impact your credit is key to improving your score. Fortunately, it’s quite straightforward but being consistent is important.
As we mentioned earlier, payment history is the most important factor in credit score calculations. With that in mind, paying all your bills on time should be your top priority. This includes all loans and credit card bills as well as rent, utilities and phone bills. Consistent on-time payments will have a positive influence on your credit score. Late payments or partial payments will hurt your score. Setting up auto-payments is the best way to ensure that all bills are paid on time. If that’s not possible, set up reminders on your calendar or phone so you don’t miss a payment.
This helps lower your credit utilization ratio, which is another important factor in calculating your score. Here’s how to calculate your credit utilization ratio:
Lenders generally like to see low ratios of 30% or less. If yours is lower than 30% you’re okay. If it’s on the higher side, make an effort to use less credit or pay off debt to keep your credit card balances low.
Keeping older credit cards open adds to the length of your credit history. A longer credit history can boost your credit score by up to 15%. It’s a good idea to keep your old credit cards open even if you’re not using them. This is of course as long as they’re not costing you money by way of annual fees.
Having extra credit may seem like a good idea but opening new accounts simply because you can, will damage your credit several different ways. For one thing, it will trigger too many hard inquiries on your credit report. Every hard inquiry hurts your credit a little. Multiple inquiries can do a lot of damage that will take years to recover from. Hard inquiries remain on your credit report for two years. Another problem with opening multiple credit accounts is that it tempts you to overspend. This increases the risk of spending unnecessarily and accumulating excessive debt.
Having both, installment and revolving accounts is good for your credit score. But for all the reasons mentioned above, it’s not a good idea to take on new credit unless absolutely necessarily. That could do more harm than good.
Inaccurate information on your report could lower your score for no fault of yours. If you find any inaccuracies on your report, dispute the information and get it corrected right away. Doing this regularly you can spot errors and get them rectified before they do significant damage. When you check your own credit report, it’s considered a soft inquiry, which won’t affect your score.
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