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.
This article 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, the creator of the FICO score, has released some of the facts used to do the math.
FICO evaluates your credit report’s information 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.
Tips: Pay all of your bills on time, every time. Set up auto-pay if you frequently forget to make your payments on time.
30% Amount owed (Credit utilization ratio):
The balance 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.
Tips: Keep your credit utilization ratio below 30% at all times.
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 positively affect your score.
Tips: Never close your credit accounts unless absolutely necessary. Set up at least one payment to paid with each credit card to prevent them from being closed by your creditor due to inactivity.
10% Types of Credit Accounts: Having a good mix of different types of credit (i.e., Revolving, Installment and mortgage loans)
Tips: Open several different types of accounts, from credit cards to auto loans. It’s good to have a personal loan or credit card on your credit history even if you don’t need one.
10% New Credit: New accounts, credit inquiries (hard and soft inquiries)
Tips: You have a rate shopping window where you can apply with multiple lenders or creditors within 14 days and it is only counted as a single inquiry. When you shop for a loan or credit account make sure you apply with multiple lenders within the rate shopping window.
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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 creditworthiness.
A few points can be the difference between qualifying for a loan with a good interest rate and being denied altogether.
Low interest rates will save you thousands of dollars over your lifetime.