In the US, your credit rating is extremely important. Having a good score opens doors for you and an unsatisfactory score will smash them in your face. Your credit score represents the risk that the lender undertakes to loan you money and determines how big your loan can be. In a lot of ways, the less you need to borrow money the more money you will be able to borrow. So, what are the factors that help calculate credit scores?
1. Payment and Derogatory Marks
The record of payments you have made to all your creditors is the biggest factor (35% of your score) that’s taken into consideration when figuring out your credit rating. It does not take much to worsen your score. Late payments take their toll and should be avoided. Payment history is calculated as total on time payments divided by total payments. Anything less than 97% is considered very poor. Of course, missed payments and defaults on debts will make a greater mark. Any derogatory mark on your credit report will remain there for 7 years, with generally no exclusion. These include accounts in collection, bankruptcy, foreclosure, or tax liens. Even if you’ve paid off the debt, it will most likely not be erased from your report until the 7-year period is up. It will simply be categorized as a closed collection.
2. Credit card usage ratio
Your credit card usage ratio (30% of your score) compares the sum of credit you have accessible to you to the total you are consuming. Your score is healthier (higher) if you are not utilizing all your credit. If you ponder that paying off an account and closing it is a sound idea, think again. That might drop your score in this department. The best resolution is to have numerous accounts open and not use most them. This is viewed upon as an advantage by potential lenders. This is calculated as your total credit card balances divided by your total credit card limits. A utilization of credit below 9% is considered excellent. Anything above 75% is considered very poor.
3. Credit history length
How long you have been using credit is another issue when it comes to how to determine credit scores–it accounts for about 15%. Again, if you recall that your credit score is what lenders are looking at to determine your loan eligibility, you can understand why this is significant. They tend to view somebody who has extended credit history and a few marks against him/her as more favorable than someone with a short, perfect credit history. This is a good reason to have your kids start making credit history early (and in a responsible way with your guidance). Try to keep accounts open to increase your average age of credit history. Less than 2 years is considered very poor and an average credit history greater than 9 years is excellent.
4.Credit variety and inquires
This makes up about 10% of your score. Believe it or not, it aids your score if you have several kinds of debt (mortgage, credit cards, car loans, etc.). Anything greater than 20 accounts is considered excellent and anything less than 5 is very poor. However, it hurts your score when applying for lines of credit. Several hard inquires could suggest to lenders that you are being denied by other lenders or that you are desperate for a loan. Ideally you want 0 hard inquires on your report. Once you begin to get over 5 your entering bad space. Soft inquires used for pre-approved loans and services like credit karma do not harm your credit.
This comprises how long you’ve been at your job; how stable the job is and how long you’ve resided at your current address. If you have been at your address for less than 3 years, this is considered less than stable.
Now you know what factors are used to calculate credit scores. Understanding them is important because it allows you to act on certain aspects that you have the power to change. Hopefully you can use these standards to establish worthy credit or bring your current score up a few notches.