Most people understand that they have a credit score. Most understand that their scores affect their credit. But many don’t understand exactly what a credit score is, or its significance.
A credit score is a number that lenders who are considering extending credit to you will use to determine the level of risk involved. In other words, when you apply for a loan, a lender looks to this number to see not only if you should receive the loan, but also whether you are likely to repay it. If you have a high credit score, the lender will feel at ease in lending to you. A lower score, however, will likely spell disaster for the lender, and equal to no loan for you.
How are credit scores calculated? The scores are determined by taking data from your credit reports, producing a total. There are variances among the three credit bureaus, however, because the bureaus have their own criteria for calculation.
Credit scores contain the following data: 35 percent payment history, 30 percent debt you owe, 15 percent length of your credit history, 10 percent types of credit used, and 10 percent new credit. Let’s define each of these terms.
Your payment history includes the number of accounts you’ve paid according to terms, negative public records and collections notices and delinquent accounts. Your total debt includes how much you owe on accounts, how much of your revolving lines of credit you’ve used, amounts you owe on installment loans and the number of zero balance accounts.
To define your length of credit history is easy: it’s how long you’ve had credit, including the length of time you’ve had an account and the time since the last account activity. Types of credit simply means the mixture of different types of accounts you have – and bear in mind that it is best to have a mix. It shows you can handle various types of debt.
New credit includes the number of accounts you’ve recently opened, as well as the proportion of new accounts to total accounts. You don’t want a lot of new credit applications, which can indicate to potential lenders that you’ve overextended yourself.
What’s a good credit score? Scores range from 340 to 850, and the higher your score the better. A high score guarantees you better rates and terms. A score over 700 us considered good, but if your score is lower, don’t fret. You can work to improve your score and establish better credit.
To do so, simply pay your bills on time, every time, and review your report at least once a year, to be sure there are no errors or fraudulent entries.
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