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How Does a Credit Score Work? (Factors & Ways to Improve)

By June 24, 2022No Comments
how credit score work

How Does a Credit Score Work? 

Your credit score work & be considered while looking for the best loan conditions or when applying for a new apartment lease. This is so lenders can see how creditworthy you are generally and how likely you are to make payments on schedule. It’s essential to comprehend how this significant number is computed and what you may do to boost it to maximize your score and raise your likelihood of acceptance.

To be of service, we built a one-stop-shop for resources relating to credit scores, including ranges, how they function, and what you can do to enhance your credit profile.

What is a Credit Score?

A borrower’s risk to a lender is quantified by their credit score or, put another way, by how likely they are to repay a loan on time. Credit scores typically range from 300 to 850, with higher scores giving applicants a better chance of acceptance and more affordable rates.

Personal Credit Score Types

FICO and VantageScore, two significant credit scoring firms, have their proprietary scoring algorithms. For the most popular models, score ranges are consistent, although there are minor variations in the factors taken into account for each computation. Similar to how each scoring convention sets its minimum scoring standards, it also gathers data from a unique collection of bureaus.

Each customer gets a unique VantageScore since the three main credit bureaus developed it. In contrast, the information in a borrower’s Experian, Equifax, and TransUnion reports might affect the bureau-specific scoring models used by FICO.

Additionally, the two main scoring models handle fresh borrowers differently. Borrowers must have an account six months old or older and activity on that account during the previous six months for FICO to calculate a score. As long as the customer has at least one history, regardless of age, VantageScore may generate a credit score.

How Does It Work?

Credit scores determine a person’s likelihood of being approved for various financial products, including credit cards, auto loans, mortgages, and apartment leases. The interest rate and down payment needed is also determined by the lender using the borrower’s credit score. Even when creating new accounts with local utilities, scores may be utilized to determine whether a consumer would pay their bills on time.

The most popular scoring models are FICO and VantageScore, based on data provided by the three major credit bureaus—Experian, Equifax, and TransUnion. Each scoring model gives different things, including payment history, sums owing, and duration of credit that signify a borrower’s creditworthiness weight. Individual lenders may, however, also use their secret algorithms to determine credit ratings.

What Are the Factors Affecting Credit Scores?

In the US, Experian, Equifax, and Transunion are the three leading credit reporting companies that track, update, and record customer credit histories. There may be variations in the data gathered by the three credit bureaus, but there are five critical elements taken into account when determining a credit score:

  • Financial history
  • Amount due in full
  • Credit history’s duration
  • Credit categories
  • extra credit

Ranges of Credit Scores

While VantageScore versions 3.0 and 4.0 and FICO-based scores vary from 300 to 850, industry-specific FICO scores range from 250 to 900. Generally speaking, a credit score of 700 or greater is acceptable, and one that surpasses 800 is exceptional. Each scoring convention classifies customers differently. The FICO Score and VantageScore ranges are most often utilized.

35% of payment history

With a 35 percent weighting, payment history makes up the most significant component of a consumer’s credit score. Scoring models check for late-payments and then consider the lateness’s severity, the number of delinquent payments, and how recently the late payments were made when determining a borrower’s creditworthiness.

Even while a single late payment is unlikely to have a significant negative influence on your credit score, it still may. A trend of late payments or payments that are more than 60 days overdue, on the other hand, is more detrimental. You may improve this area of your credit score by consistently paying on-time payments and rejecting any late payments you feel were made by mistake.

30% of accounts owned

The total amount of outstanding debt—or accounts owed—that a borrower has on their credit report contributes to 30% of a consumer’s FICO credit score, just behind payment history. The amount of total debt held by the consumer, the number of accounts with balances, the credit usage ratios, and the sorts of funds (such as credit cards, mortgages, and student loans) are all considered by scoring models.

By reducing credit card balances and minimizing future card usage, you may improve this aspect of your credit score. To keep your balances under control, make timely payments on installment loans (such as mortgages and vehicle loans).

Duration of Credit History: 15%

The third most important aspect in determining a consumer’s credit score is the duration of their credit history, which contributes 15% to that score. The scoring models determine the average age of all accounts, the periods of the oldest and newest versions, the length each account has been open, and the date on which each version was last active to assess how long a borrower’s credit history has been established.

It’s recommended to avoid closing older accounts that are still in good standing because of this, particularly if you intend to apply for a mortgage or other sizable loan shortly. It usually takes time and perseverance to increase this component of your score. Adding yourself as an authorized user to an established account in good standing may increase the age of your credit and raise your rating.

10% of the credit mix

The assortment of loans, credit cards, and other accounts a borrower has made up their credit mix. Although it only contributes 10% to the computation of a credit score, scoring models favor borrowers with a range of accounts. This covers installment accounts, like personal loans and mortgages, and revolving credit, like credit cards.

Examine your credit record and look for gaps in your credit mix to make the most of this element. For instance, if your credit record shows no revolving accounts, applying for a new credit card can be beneficial. Applying for a modest personal loan and making timely payments on it might help borrowers who do not already have any installment debts.

10% for new credit

Recent inquiries, often known as credit checks, are considered by scoring algorithms when determining a borrower’s overall creditworthiness. This category, which makes up only 10% of the computation of a person’s credit score, also considers the number and date of newly created accounts on the borrower’s credit report.

Lenders generally are less interested in borrowers who create many credit accounts at once since they are riskier. In light of this, it’s still advisable to restrict new credit inquiries on your report if you intend to apply for a mortgage or vehicle loan soon, even if new credit isn’t as influential as other factors.

How to Raise Your Credit Rating

It might take time and be stressful to build your credit profile. Fortunately, there are specific actions you can do to maintain control over your money and improve your creditworthiness. Think about the following advice to raise your credit score:

  • Pay your bills consistently and on schedule.
  • Ask for more credit on your current accounts.
  • Examine your credit report and challenge any mistakes.
  • To establish credit, apply for one of the most significant first cards.
  • Keep your accounts open, particularly more established ones.
  • Track your credit score with a credit monitoring service, and look for any warning signs of identity theft.

Bottom Line

One statistic that has a significant impact on your financial future is your credit score. You may qualify for cheaper interest rates with a great credit score, which would cut the cost of any line of credit you take up. However, it is your responsibility as the borrower to maintain good credit so that you may access future lending alternatives if necessary.

Luke Pitt