Understanding What Your Credit Score Means How It’s Calculated

person looking over their credit score

Whether you are applying for a new house or apartment, a loan at the bank or a department store credit card, one of the first things a creditor will ask for is your credit score. For many people, understanding credit scores can seem pretty daunting, especially when they do not know how the scoring system works or why it is so important. Luckily, the financial system behind it all is not that complicated, and Liberty Debt Relief is here to help you navigate your score.

What is a Credit Score, Exactly?

To really get a grasp on how important credit is as a whole, it is first important to understand what a credit score actually is. Essentially, a credit score is a simple indicator of your financial reliability used by potential lenders. The score considers five primary factors: Your payment history, credit length, credit utilization, new credit accounts, and the breakdown of your types of credit. Each category has a different weight on your score, which will be broken down below, and is provided on a scale of 300 to 850, the latter being the best score possible.

The better your score, the better financial deals you will get in regards to loan amounts and interest rates. It is important to note that, when you request a new loan or card from a lender, they may complete a hard check of your credit report before granting you a line of credit or loan. Each of these checks goes on your report and too many within a 12-month period can actually lower your score. That’s why it’s important to carefully determine whether or not you need the new loan or card or if you just want it.

Your Payment History

When considering how a credit score is calculated, your payment history takes the lead. Accounting for 35 percent of the total score, your payment history is comprised of various information, including past bankruptcies, settlements, liens and delinquencies, the amount of money you still owe on accounts, and how often you make payments on time versus late, among others.

For FICO — the company that most lenders rely on for tabulating creditworthiness — your history of paying back debts is a large indicator of how well you will handle similar situations in the future. Any and all types of financial loans, including but not limited to mortgages, student loans, credit cards, and personal loans from the prior 10 years, will be included within this subscore. To increase this part of your credit score, make your payments in full and on time and work to make sure you pay off outstanding balances as quickly as possible.

How Long Your Credit History Is

Knowing how long you have held each of your accounts is a vital part of understanding your credit score because the length of your credit history makes up 15 percent of your total score. Generally speaking, people who have held accounts with lenders the longest also have higher credit scores. This is because they have had more time to pay off outstanding debt, remain reliable consumers, and overall gain more financial experience.

For this part of your score, FICO looks at your overall credit history to find out the age of it in its entirety, the age of your newest line of credit, and the average length of all your credit accounts that you have currently and in the past. They also look at how often you use existing accounts.

How you Utilize Your Credit

When most people think of how a credit score is calculated, they automatically think of their purchases. Credit utilization actually accounts for 30 percent of your total score. It essentially tells borrowers how much money you have borrowed and how frequently you borrow it. This category demonstrates to potential lenders how risky you are for their business, and it is why you should typically keep what you owe under 50 percent of your available credit.

For example, people who max out their credit cards every month may suffer from a lower credit score because constantly exhausting funds gives the impression that you cannot afford your lifestyle with your income as it is. Using $2,990 of your $3,000 credit card limit one month, however, does not necessarily mean your credit score will automatically drop, but doing so month after month with no attempts to pay off the outstanding balance may.

New Forms of Credit

An important note to understand about your credit score is that not every financial move has such a heavy effect. New credit, for instance, makes up just 10 percent of your total score. When looking at your credit report, one of the things lenders look for is your most recent financial additions. They want to see any new financial loans you have taken on, how much they are for, and how close together you opened them.

Someone who has recently opened two new credit cards, one personal loan, and one department store card may come off as much riskier than someone who has only opened one additional account in the past two years. This is because a sudden burst in credit accounts gives the impression that you were in dire needs of funds, which can be a red flag. Lenders are more likely to work with people who only borrow money as needed, rather than as wanted.

The Kinds of Credit You Have in Your Portfolio

The other small fraction of how a credit score is calculated is the portfolio diversity itself. FICO designates 10 percent of your credit score to the types of financial lines you have established over the years. While having one of every single kind of financial account in the world is not necessary, having a healthy mix of loans, credit cards, and department store accounts can help you demonstrate that you are reliable on all points of the spectrum. It also makes you seem more desirable to all kinds of financial lenders that you may want to work with in the future.

Get Back on Track with a Settlement

Thoroughly understanding and seeking to improve your credit can be challenging for many people in difficult financial situations. Contact debt consultants at Liberty Debt Relief today to find out what your specific credit report means for your future and how you can improve your score in the most efficient way possible.

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