Not many people are aware of the credit scoring system or even their credit score. Your credit score is critical information that is used to check if you qualify for credit cards, mortgages, and loans. Your scores tell creditors your potential credit risk and if you can repay loans. Credit scores range between 300-850, with 850 as the highest possible credit rating.
Understanding how your credit score is calculated and knowing the factors that affect it helps you make adjustments on your financial habits. Here are five things you need to understand about credit scores:
- Scoring System
In the US, lenders use two main credit scoring systems: Fair Isaac Corporation, or FICO, or VantageScore. The two systems are not equal, and FICO is the more valuable because three major credit bureaus use this system to evaluate its clients.
So, how is your credit score calculated? Here are the elements that make up your score:
- Payment History (35%) – This is considered the most important component of your credit score. This shows how you can be trusted to repay the amount you owe. When you make balance transfers to your credit cards, it also affects your credit score, and it’s logged in on your payment history. To know more about how balance transfers affect your credit score, visit this link: https://lendvia.com/news/how-balance-transfers-affect-credit-scores/
Lenders check if you pay your bills on time. Lenders also check how late you make payments in case you’ve paid late. The later you pay your debts, the worse it is for your score.
- Amount You Owe (30%) – The credit utilization ratio measures how much you owe versus your available credit. Evaluating this component helps lenders check if you are about to reach your breaking point, which might lead to financial instability.
- Credit History (15%) – Lenders check how long you have been using credit. Long credit history is helpful, but short credit history is also fine as long as you make your payments on time.
- New Credit (10%) – FICO scoring also considers how many new accounts you have applied for and when was the last time you applied for a new account.
- Types of Credit (10%) – FICO also checks if you have a mix of different types of credit like credit cards, installment loans, and mortgages.
- What is a Good Credit Score?
If your lender uses the FICO scoring system, a bad credit score is between 300-579. A good credit score is at least 670, and you can go as high as 800-850 to get an excellent rating.
If your lender is using the VantageScore system, a very poor credit score is between 300-499, a good credit score is at least 661, and you can go as high as 781-850 to get an excellent rating.
- Disadvantages of Having Bad Credit Rating.
Having a poor or fair credit score comes with many disadvantages. The first one is that you will less likely be approved when applying for credit cards or personal loans. If you are looking to borrow money to get out of debt, you will have a hard time finding lenders who will trust you. But you should not lose all hope. Some lenders offer loans for bad credit holders. These lenders provide you with reasonable interest and payment terms.
- Benefits of Having Good Scores
Good and excellent credit ratings are a huge help in case you need help with your financial obligations. Aside from getting your loans or credit cards approved, you can also receive competitive rewards, better payment terms, and lower interest rates. It also makes it easier to get a car or house loan.
- How to Improve Your Credit Score
If you already have a bad credit rating, you should not give up as there are still many ways you can boost your credit scores. Here are some ways to help you:
- Pay on time – If you have a bad payment history, now is the perfect time to start paying your dues on time. Remember that payment history is the most important aspect of your score.
- Pay in full if you can – To reduce your utilization rate, you should pay more than the minimum payment for your dues.
- Do not open many new accounts – Each time you apply for credit or loans, an inquiry appears in your credit report. Once the lenders see that you are opening other accounts that may affect your capacity to pay, it is most likely you will get a bad credit rating.
Knowing your credit score is important not only because it helps you borrow from other lenders, but also because it evaluates your financial habits. Getting a bad credit score would mean that you are not paying your dues on time or you are borrowing too much as compared to your capacity to pay. Understanding how the credit system works helps you make adjustments on your payments and your financial decisions as well. There are many services online which can help you evaluate your rating and give you advice on how to improve your scores.