How Your Credit Score Is Calculated?

Your credit score is a numerical representation of your creditworthiness, and it plays a crucial role in determining your financial opportunities. While the formula used to calculate it may seem complex, it primarily takes into account five main factors: payment history, amounts owed, length of credit history, credit mix, and new credit. Payment history carries the most weight, considering whether you have paid your bills on time. The amounts owed factor assesses how much credit you are currently using compared to your total available credit. The length of your credit history measures the age of your accounts, while credit mix examines the different types of credit you have utilized. Lastly, new credit evaluates any recent applications and opened accounts. By understanding how your credit score is calculated, you are better equipped to improve and maintain a healthy credit profile.

What Makes up Your Credit Score?

Your credit score not only determines your eligibility for loans, credit cards, and mortgages, but it can also have an impact on your financial future. While many people are aware of the importance of maintaining a good credit score, not everyone understands the factors that make up this crucial financial metric.

1. Payment History:
   The most influential factor in determining your credit score is your payment history. It accounts for approximately 35% of your overall score. Lenders want to see a consistent track record of paying bills on time and in full. Late payments, defaults, and bankruptcies can adversely affect your credit score.

2. Credit Utilization:
   Credit utilization refers to the amount of credit you are using compared to your total available credit. It contributes around 30% to your credit score. Ideally, it is recommended to keep your credit utilization ratio below 30%. High utilization indicates a higher risk to lenders, so be mindful of this factor when using your credit cards.
   
   
3. Length of Credit History:
   The length of time you've been using credit plays a significant role in determining your creditworthiness. Approximately 15% of your credit score is based on this factor. Lenders prefer borrowers with a longer credit history as it gives them a better understanding of your financial behavior and the ability to manage credit responsibly.
   
   
4. Credit Mix:
   Having a diverse portfolio of credit types can positively impact your credit score. Credit mix contributes about 10% to your overall score. Maintaining a healthy balance between installment loans (such as mortgages or auto loans) and revolving accounts (like credit cards) showcases your ability to handle different types of debts.
   
   
5. New Credit Applications:
   Every time you apply for new credit, such as a loan or credit card, it triggers a hard inquiry on your credit report. Multiple hard inquiries within a short period can negatively impact your credit score. This factor makes up roughly 10% of your credit score. It is crucial to be selective in applying for new credit and only do so when necessary.
   
   
6. Public Records and Collections:
   Negative public records and collections, such as liens, judgments, and bankruptcies, can significantly damage your credit score. These derogatory items, if present, can stay on your credit report for several years. Lenders perceive them as indications of financial instability and risk. It is essential to address these issues promptly to minimize their impact.

What’s the Difference Between FICO and VantageScore?

When it comes to credit scores, two of the most commonly used models are FICO and VantageScore. While both are designed to assess a person's creditworthiness, there are some key differences between them.

Firstly, the companies behind these credit scoring models are different. FICO (Fair Isaac Corporation) is a well-established company that has been calculating credit scores for decades. On the other hand, VantageScore was created by the three major credit reporting agencies - Experian, TransUnion, and Equifax - as a joint venture in 2006.

Secondly, the scoring scales used by FICO and VantageScore differ slightly. FICO scores range from 300 to 850, with higher scores indicating better creditworthiness. VantageScore, on the other hand, uses a scale of 300 to 850 for its latest version (VantageScore 4.0). However, previous versions of VantageScore had a different scale that ranged from 501 to 990.

Another point of differentiation lies in the way credit information is weighted. FICO uses five main categories to calculate scores: payment history, amounts owed, length of credit history, credit mix, and new credit. Each category holds a different level of importance based on the impact it has on creditworthiness. VantageScore also considers these factors but places greater emphasis on credit utilization (amounts owed) and the depth of your credit file (credit mix and length of credit history).

Furthermore, the time it takes for each model to generate a credit score differs. FICO scores can be generated quickly, often within minutes, given its years of experience. VantageScore models, particularly the latest versions, claim to be able to provide a score more quickly than a traditional FICO score.

Despite these differences, both FICO and VantageScore aim to provide lenders with an accurate prediction of a borrower's creditworthiness. While each model may yield slightly different results, lenders generally consider both scores to be reliable indicators of credit risk.

Negative Factors That Impact Your Credit Score

Maintaining a good credit score is crucial for financial stability and access to various lending opportunities. However, certain factors can adversely affect your credit score, making it difficult for you to secure loans, get favorable interest rates, or even rent an apartment.

1. Late Payments:
   Regularly missing payment due dates or consistently paying bills late can significantly harm your credit score. Payment history is a vital component of your credit score, accounting for about 35% of its calculation. Late payments can show a pattern of financial irresponsibility, leading to a lower credit score and potential difficulty in obtaining future credit.
   
   
2. High Credit Utilization:
   Credit utilization represents the percentage of your available credit limit that you are utilizing at any given time. Maxing out your credit cards or consistently utilizing a high percentage of your available credit can negatively impact your credit score. It is generally recommended to keep credit utilization below 30% to maintain a healthy credit score.

2. Collections and Charge-Offs:
   Having accounts sent to collections or charged off by creditors due to non-payment can seriously damage your credit score. A collection account arises when a debt is sold or transferred to a collection agency after being delinquent for an extended period. A charge-off occurs when the creditor assumes that the debt will not be repaid and declares it as a loss for accounting purposes. Both collections and charge-offs are considered negative marks and can stay on your credit report for up to seven years.
   
   
3. Bankruptcy or Foreclosure:
   Declaring bankruptcy or experiencing foreclosure on a property can have a severe impact on your credit score. When you file for bankruptcy, it remains on your credit report for up to ten years, making it difficult to obtain new credit during that time. Similarly, foreclosure, which occurs when you fail to make mortgage payments resulting in the loss of your property, can significantly lower your credit score and make it challenging to qualify for future loans or mortgages.
   
   
4. Numerous Credit Applications:
   Applying for credit too frequently can negatively affect your credit score. When you submit multiple credit applications within a short period, it raises concerns among lenders about your financial stability. Each application results in a hard inquiry on your credit report, which can stay on your file for up to two years and have a temporary negative impact on your credit score.

How to Improve Your Credit Score?

1. Pay your bills on time: One of the most important factors affecting your credit score is your payment history. Make sure to pay all of your bills, including credit card payments, loan repayments, and utility bills, on time. Late payments can have a negative impact on your credit score, so set up reminders or automatic payments to avoid any mishaps.
   
   
2. Reduce your credit utilization ratio: Your credit utilization ratio is the amount of credit you are using compared to your total available credit. It is generally recommended to keep your credit utilization below 30%. You can achieve this by paying off debt and not maxing out your credit cards. If possible, try to pay off your balances in full each month.
   
   
3. Check your credit report regularly: It is essential to review your credit report on a regular basis to identify any errors or fraudulent activities. You can get a free copy of your report from each of the three credit bureaus (Experian, Equifax, and TransUnion) once a year. If you spot any inaccuracies, contact the respective credit bureau to have them corrected.
   
   
4. Diversify your credit: Having a mix of different types of credit accounts, such as credit cards, loans, and mortgages, can positively impact your credit score. Lenders like to see that you can handle different types of credit responsibly. However, make sure to only take on new credit accounts if necessary and manage them wisely.
   
   
5. Keep old accounts open: Closing old credit card accounts may seem like a good idea to simplify your finances, but it can negatively affect your credit score. Closing accounts reduces the total amount of available credit and shortens your average credit history. Instead, keep the accounts open and use them responsibly to build a positive credit history.
   
   
6. Avoid applying for multiple new credit accounts at once: Each time you apply for new credit, it results in a hard inquiry on your credit report. Multiple inquiries within a short period can have a negative impact on your score. Only apply for credit when needed and do your research to find the best offer for your specific situation.
   
   
7. Consider a secured credit card or credit-builder loan: If you have a poor or limited credit history, it can be challenging to improve your credit score. However, there are options available to help you establish or rebuild your credit. Secured credit cards require a refundable security deposit and are easier to obtain than regular credit cards. Alternatively, credit-builder loans allow you to save money while improving your credit history.
   
   
8. Pay off outstanding debts: If you have any outstanding debts in collections or charged off accounts, it's essential to address them. Try negotiating with creditors or collection agencies to come up with a repayment plan. Paying off these debts can have a positive impact on your credit score over time.
   
   
9. Be patient and consistent: Improving your credit score takes time and effort. There are no quick fixes or overnight solutions. Stay consistent with your positive financial habits, pay your bills on time, and maintain a low credit utilization ratio. Over time, you will see gradual improvements in your credit score.
   
   
10. Seek professional help if needed: If you're overwhelmed or struggling to improve your credit score on your own, consider seeking professional help from a reputable credit counseling agency. They can guide you through the process and provide personalized advice based on your unique situation.

Your credit score holds more importance than just being three digits; it is vital for your financial well-being. If your score is not satisfactory, there are remedies available. To begin, obtain a complimentary copy of your credit report. Although comprehending the aspects that determine a credit score requires time, it is immensely beneficial in the future. There are numerous free online resources and the option to seek advice from a credit repair professional for tailored assistance.

Call on (888) 803-7889 to get free credit repair consultation now!