Credit scores provide a numeric representation of an individual’s creditworthiness, indicating how likely they are to repay their debts on time. These scores play a crucial role in determining whether lenders will approve someone for credit products like loans and credit cards, as well as influencing the terms and interest rates associated with those products. While the specific credit scoring models may differ by country and credit bureaus, the widely used FICO score developed by the Fair Isaac Corporation is most common. Here’s a general overview of how credit scores are calculated:
1. Payment history accounts for 35% of the FICO score. This factor holds significant weight in calculating credit scores. It reflects how consistently one has made payments on their debts, such as loans, mortgages and credit cards. Late payments, defaults or accounts in collections can negatively impact your score, while a history of making timely payments has a positive effect.
2. Credit utilization accounts for 30% of the FICO score. Credit utilization refers to the percentage of available credit that one is currently using. It is calculated by dividing total credit card balances by total credit card limits. Maintaining a low credit utilization rate (ideally below 30%), demonstrates responsible management and can have a positive impact on your score.
3. The length of your credit history, which accounts for 15% of your FICO score, takes into consideration the age of your oldest credit account, the average age of all your accounts and the age of each individual account. A longer credit history generally shows that you have more experience with credit, which can positively impact your score.
4. Credit mix, accounting for 10% of your FICO score, is another important factor. Lenders like to see that you can responsibly handle different types of credit. Having a variety of credit accounts such as credit cards, installment loans and retail accounts can have a positive influence on your score.
5. New credit inquiries make up 10% of your FICO score. When you apply for new credit, it results in a hard inquiry being recorded on your credit report. Too many inquiries within a short period may indicate financial difficulties and can have a negative impact on your score. However, multiple inquiries related to rate shopping for the same type of credit (like auto loans or mortgages) within a specific timeframe (usually around 14-45 days) are treated as one inquiry.
It’s important to keep in mind that different credit bureaus may use slightly different scoring models and lenders might also employ customized scoring models to meet their specific requirements. Furthermore, there are other elements to consider in assessing your creditworthiness, such as public records which include bankruptcies and liens. However, traditional credit scores may not always account for these factors.
To ensure a strong credit score, it is crucial to make timely payments, keep your credit card balances low, refrain from opening multiple new accounts too quickly and maintain a diverse range of credit types over time. Regularly reviewing your credit report and promptly addressing any errors or inaccuracies can also contribute to enhancing your creditworthiness.