How your credit score is calculated?
Subtitle: The credit score, a significant influence on your interest rates, is determined by five key factors, allowing you to have control over them.
In the world of finance, a credit score is a report that reflects your financial behavior and is used by lenders and landlords to assess your level of responsibility with money. It is a numerical value that typically ranges from 300 to 850 and is calculated based on five key factors. Understanding how credit scores are calculated can help you improve your financial situation and pave the way for a brighter future.
Credit scores are generated by reporting agencies or credit bureaus, which receive information about an individual’s payment behavior, bills history, and credit-related activities from banks and financial institutions. Regardless of the credit agency or bureau, credit scores are calculated using five major factors, each of which plays a significant role in determining one’s creditworthiness.
1. Payment History: This is the most critical factor, accounting for about 35% of the credit score. It reflects whether you have made timely payments on your bills, loans, and credit card dues. Consistently paying on time has a positive impact on your credit score, while late or missed payments can lower it.
2. Credit Utilization: This factor contributes about 30% to the credit score. It measures the amount of credit you are currently using compared to your total available credit. Keeping your credit card balances low relative to your credit limits can improve your credit score.
3. Length of Credit History: Approximately 15% of the credit score is based on the length of your credit history. It takes into account how long you have had credit accounts open. A longer credit history is generally viewed favorably as it provides a better understanding of your credit management over time.
4. New Credit: About 10% of the credit score is influenced by new credit applications and accounts. Opening multiple new credit accounts in a short period may suggest financial instability and could negatively impact your credit score.
5. Credit Mix: This factor also contributes around 10% to the credit score. It considers the types of credit you have, such as credit cards, loans, and mortgages. A diverse credit mix may positively influence your score, demonstrating your ability to handle different types of credit responsibly.
These five factors, along with some other minor considerations, are used by credit scoring models like FICO to calculate an individual’s credit score. Understanding these factors is crucial for managing your credit responsibly and maintaining a good credit score, which can open doors to better financial opportunities.
It is important to note that different sources may provide different credit score ratings. This variation occurs because there are multiple companies that provide credit score ratings to banks and financial institutions. The prominent names in the industry are FICO and VantageScore. While both companies use the same data, they weigh the information slightly differently.
FICO scores have been in use for a long time and are widely recognized and trusted by lenders. They range from 300 to 850, with higher scores indicating better credit. On the other hand, VantageScore is a newer model developed jointly by the three major credit bureaus. Like FICO scores, VantageScores also range from 300 to 850. While both models consider similar factors like payment history and credit utilization, VantageScore claims to be more inclusive by considering a broader range of credit data.
In summary, both FICO and VantageScore can provide valuable insights into your credit health. It is important to monitor and maintain good credit habits regardless of which model lenders use. It is worth noting that if you have an excellent VantageScore, it is likely that your FICO score will also be high.
