Your credit score can have a profound effect on your financial well-being.
You know you need a good credit score but aren’t there yet.
First, you need to understand how your credit score is calculated.
In this article we will explain exactly how your credit scores are calculated, tips to improve your score, and expose credit myths
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How Credit Scores Are Calculated
If credit score calculations seem mysterious to you, you are not alone. The exact way to calculate credit score is a closely-guarded secret, but Fair Isaac, creator of the FICO score, has released some of the facts that are used to do the math.
FICO evaluates the information on your credit report and assigns a credit score between 300 and 850 based on the following five criteria.
35% Payment History: Your history of paying your bills on time. This includes:
- Number of collection accounts
- Late payments
- Number of accounts in good standing
- 70% of your score is based on your credit history over the previous 2 years.
30% Amount owed (Credit utilization ratio):
The balances on your credit cards compared to the credit limit is your credit utilization ratio. Basically, it’s the amount of available credit you’re using. Example: $10,000 credit limit with a $3,000 balance = 30% credit utilization ratio.
15% Length of Credit History: The longer you have had credit the more established you appear. Keeping your accounts open as long as possible keeps your average age of accounts high, which will have a positive effect on your score.
10% Types of Credit Accounts: Having a good mix of different types of credit (i.e. Revolving, Installment and mortgage loans)
10% New Credit: New accounts, credit inquiries (hard and soft inquiries)
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Bad Credit Makes it Difficult to Qualify for a Loan
Having a credit score that is too low can keep you from getting new credit, starting a business, or buying a home.
Employers, landlords and insurance companies have started using credit scores to determine an applicant’s credit worthiness.
A few points can be the difference in qualifying for a loan with a good interest rate, and being denied all together.
Low interest rates will save you thousands of dollars over your lifetime.
Credit Score myths
Paying off collection accounts will improve your credit scores.
This is not true. Paid or unpaid, a collection account will have the same negative impact on your credit score..
Whether it has a zero balance, or a $1,000 balance it will still be a collection account that stays on your report for 7 years. It is best to dispute your collection accounts with the Credit Bureaus to see if you can get them removed from your report.
Pay the balances on your credit cards below 30% of the limits
Your credit utilization ratio is the balance on a credit card compared to the credit limit. The lower this ratio is the higher your score will be.
If you can you should try to pay off your cards each month, or keep the balances as low as possible, much lower than 30%.
Checking your credit score will hurt your credit
Checking your score online, at websites like WalletHub will not harm your score. When a lender pulls your credit score, this is a hard inquiry. A high number of hard inquiries may negatively impact your score.
If you pay a collection it will update the status to “Paid” and will help your score
The status of collection accounts is a myth created by the debt settlement industry. A collection account status does not factor into the scoring algorithm at all.
Your score is based on an algorithm that shows the chances you are to go 90 days late. Paying a collection and a status of paid, does not make you less of a risk to a lender.
For tips on improving your credit score check out our free credit repair guide.
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