When it comes to buying a house, purchasing a new vehicle or applying for a credit card, your credit score is bound to come into play. As an influential factor in a financial institute’s decision whether to loan you money or not, your success often rests on this mysterious number. What is this important score and how is it determined? Learning this will help you take steps to raising your score over time.
Your credit score is calculated by a combination of five different factors, each contributing a different ratio of influence. According to Stacy Smith, Senior Publish Education Specialist for Experian, it involves your payment history, utilization, length of credit history, recent activity and overall capacity.
Certainly the most persuasive factor in determining your current credit score, your payment history tells creditors about your likelihood of paying back any loans for which you’re currently applying. Amy Fontinelle, personal financial expert writing for Investopedia, explains that consistently paying your credit card, utility bills, student loan and other bills on time month after month will produce a higher credit score that reflects your financial reliability. On the other hand, a track record of late or below-minimum payments will bring your credit score down.
Having a credit card and consistently using it will be reflected positively on your credit score over time, but using it too much could actually harm it. According to Dana Dratch, contributor at Bankrate.com, it’s important to keep your balance below 30 percent of your limit on every credit card—both individually and total. For example, if you have a $7,500 credit limit, you don’t want the balance to exceed $1,500.
So, if you’re maxing out your credit card every month for the bonus points—even if you’re paying the bill in full each month—that probably won’t look good to creditors who may see you as constantly spending in excess or charging everything to live paycheck to paycheck. If it reaches 30 percent, proactively pay the balance on the account before continuing to charge to it.
Length of credit history
This factor is not as influential as the first two and it covers multiple territories: how long has each account been open? Are all accounts still actively used or are some being neglected? Does the applicant have a variety of accounts—credit cards, auto loans, mortgages etc? This category is tricky because it is improved over time; suddenly opening a variety of accounts and using them religiously will only hurt your score, explains Smith.
While a healthy credit history is important, so is the current state. If you’ve taken on a loan or opened a new line of credit in the last 6 – 12 months and are applying to do so again, you are more likely to struggle with payments than you would be to excel. This is why you should not open multiple credit accounts around the same time, advises Smith.
To a minor degree, your credit card reflects how much outstanding debt you have and how that impacts your overall financial situation. If you have a low amount of outstanding debt and a healthy, steady income, you don’t have to worry about this being an issue.
How to read your credit score
Your credit score actually consists of three scores calculated by major credit bureaus Equifax, Experian and Transunion. Each number generally ranges between 300 (low end) and 850 (high end). The higher the three-digit number, the healthier your credit is.
If your credit score is lower than you need it to be, worry not. The number is recalculated often, and healthy financial habits will steadily raise it over time.