When it comes to managing your finances, understanding your credit score is crucial. And it is a fancy term that you might come across every other day, be it at the bank, purchasing or renting an apartment, securing loans for education (Student Debt), or even when buying most things on EMI.
But what exactly is a credit score, and if it is so important, how can you manage it well? I am here with a comprehensive guide on credit score calculations, credit score models, and actionable tips on how to improve them and maintain a healthy credit score.
But first, let’s understand what credit scores are with a simple and basic explanation.
Also Read: What is Hard Inquiry and How Does it Affect your Credit Scores?
What are Credit Scores?
A credit score is a three-digit number that signifies how well you manage your finances: your spending and saving habits, and if you are reliable to secure and repay a loan. Basically, it is a crucial factor that is assessed in making financial decisions and creditworthiness related to you as an individual.
There are multiple types of credit scoring models that showcase your credit value, and two of the famous ones are FICO Scores and VantageScore. More about each of these credit score models is in the later section of this guide.
Your credit score is based on your credit history, which includes information like the number of accounts you hold, total Debt, repayment history, hard credit inquiries, and various other factors.
All of these are collected, analyzed, and presented to consumers by three bureaus (Equifax, TransUnion, and Experian) in the US markets. Lenders, such as banks or concerned entities like landlords, refer to your credit scores before they approve your loan or lease their property on rent.
Such references are called inquiries, and there are two types of credit score inquiries: Soft inquiry and Hard inquiry. While a hard inquiry leaves a negative mark on your credit history, it doesn’t last for more than a year or two. On the contrary, soft inquiries do not leave a negative mark on your credit report and don’t involve a lot of information.
Also Read: (Review) Credit Hero Challenge – The Best 14 Days Credit Repair Course?
How are Credit Scores Calculated?
Equifax, Experian, and TransUnion are three major agencies that collect, analyze, and distribute your credit information. While the information collected by each of these bureaus may differ, there are some common factors that contribute to your credit scores.
Here are the factors with their weightage on your credit scores,
| Factor | Weightage |
|---|---|
| Payment History | 35% |
| Credit Used | 30% |
| Length of Credit History | 15% |
| Types of Credit | 10% |
| New Credit | 10% |
Let’s discuss each of these factors with an example and how you can leverage them to have a good credit score.
1. Payment History (35%):
Payment history has one of the biggest weightage when it comes to measuring your credit scores. It depicts how you have repaid the loan in the past and if it was done in a timely manner. With this data, creditors can know and assess the risk before giving out a loan.
So, if you have made timely and quick payments in the past, you can expect a better credit score and a good chance of securing a loan. Also, it portrays responsible financial behavior, which can ease the loan process.
2. Credit Used (30%):
The second biggest factor that impacts your credit score is the utilization of credit. So if you are using most of your available credit, banks may endanger it as overuse and mostly default on your total credit. Keeping your credit card balances low in proportion to your credit limits shows responsible credit management. This leaves a positive impact on your credit score. It is recommended to utilize no more than 30% of your available credit to maintain a healthy credit utilization ratio.
Furthermore, these also include multiple other factors, such as amounts owned in different types of accounts (for example, credit loan vs. installment loan), accounts with balances, credit utilization ratio, and installment loans that are still to be repaid.
Example: If you have a credit card with a $10,000 limit and consistently keep your expenses below 30% (i.e., $3,000), it indicates that you’re using credit responsibly and can boost your credit score.
3. Length of Credit History (15%):
Longer credit histories provide more data for lenders to assess your creditworthiness. It is important to maintain accounts over a long time to build a strong credit history.
Here are some of the factors,
- The age of your oldest account, newest account, and the average age of all your accounts to establish how old your credit history
- How long since your credit accounts have been open
- For how long your credit accounts have been used
The length of credit history helps bureaus understand how you have been managing your credits. If your credit repayment and usage patterns are uneven or untimely, there is a good chance that you will have lower credit scores. Your credit history is quite important for your current and future loans, so timely repayment is one of the good habits for better credit in the future.
Example: Suppose you’ve had a credit card for ten years, consistently managing it well. This lengthy credit history showcases your financial responsibility and can result in a higher credit score compared to someone with a shorter credit history.
Also Read: How Often Are Credit Scores Updated? An Investographer Guide to You
4. Credit Mix (10%):
A healthy mix of credit, such as credit cards, loans, and a mortgage, can have a positive impact on your credit score. Having different types of credit shows that you can handle various financial duties responsibly.
But what is Credit Mix? Credit Mix is the mixture of all your other revolving and installment accounts. Your credit cards, retail store cards, gas station cards, and HELOC are considered under revolving accounts. Credit bureaus monitor such accounts and look at your credit usage on them to know your financial condition. On the other hand, installment accounts such as Mortgage, Auto, and Student Loans are also a crucial contribution to your Credit Mix factor.
In addition, if you have opened several accounts in a shorter period, creditors can look at it as financial distress and may reduce your score and chances to avail of loans.
Example: Maintaining a diverse credit portfolio, including a mortgage, an auto loan, and a credit card, demonstrates your ability to handle different types of credit responsibly and can contribute to a higher credit score.
5. New Credit (10%):
If you are taking new credit even after having a lot of debts, it is likely that creditors will consider your financial situation under distress. This is when you have a short credit history and still apply for fresh loans.
New credits, though hold only 10% weightage on your credit scores, they still speak a lot about your financial habits. When you place a request for a new loan, lenders inquire about your credit history, and it is reflected on your credit report. And when there are a lot of such inquiries, lenders can consider it a drawback on your credit report.
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Credit Scoring Models: FICO and VantageScore
When it comes to measuring your credit scores, there are two popular industry standards: FICO and VantageScore. These credit models assess your credit history using multiple factors and present you with a human-understandable score. However, both VantageScore and FICO use different algorithms to assess your credit history, and you might see totally distinct scores on both of these credit models.
Let’s understand each of these credit score models in detail.
1. FICO Scores
FICO (Fair Isaac Corp) is a credit model like Vantage Score or Credit Scores that helps you monitor your credit situation with 30+ kinds of FICO Scores. It is a three-digit score ranging from 300 to 850 points, and the higher the points, the easier it is to get loans or credit.
If your FICO score range is near 750-800 points, your credit situation is exceptional, and it is easier for you to obtain new loans. With such outstanding scores, creditors are assured that you are likely to timely repay their loan, ensuring their money is safe.
Here is a much more detailed range of FICO Scores with their meanings,
| FICO Score | Meaning |
|---|---|
| 800-850 | Exceptional |
| 740-799 | Very Good |
| 670-739 | Good |
| 580-669 | Fair |
| 300-579 | Very Poor |
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2. VantageScore
VantageScore is an alternative credit score model which also ranges from 350-800 points, and the higher the points, the easier it is to get loans. Likewise, VantageScore also emphasizes the same factors as that of FICO Scores. For instance, payment history, credit utilization, length of credit history, credit mix, and new credit inquiries.
But there is one more factor that makes VantageScore better than FICO scores which is also the reason why it is gaining a lot of popularity. VantageScore places a particular emphasis on recent credit behavior, making it more responsive to recent financial activities.
VantageScore also considers alternative credit data compared to traditional algorithms. Rather than only focusing on credit cards, mortgages, and loan data from financial institutions, VantageScore also focuses on rent payments, utility bills, and telecommunications accounts, providing a more comprehensive picture of your creditworthiness.
Although VantageScore is becoming popular, creditors might still rely on FICO scores as it is widely used among all institutions. It is best to know both the scores and present them to get a better shot at securing loans.
Also Read: 10 Solid Tips on How to Prevent Credit Card Skimming?
How to Get Your Credit Scores?
As per FCRA (Fair Credit Reporting Act), you are eligible to get one free credit report every 12 months. You can get this credit report from the Annual Credit Report website, and this credit report includes various information such as what businesses have given you credit or loans, credit limit, payment history, and more.
However, these are still credit reports and not your credit scores.
There are several credit monitoring platforms that help you get your credit scores. One of the best platforms I encountered is myFICO, the official consumer division of FICO SCORE and FICO. In addition, myFICO not only monitors your credit score but also helps you selectively track scores for mortgages, auto loans, identity information, and more.
So, you can mainly understand myFICO into two parts – Credit monitoring and identity theft. However, identity theft with myFICO is managed by third-party American Bankers Insurance Company with their own policies, terms, and conditions.
You can learn more about myFICO in my detailed review.
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How to Improve Your Credit Scores?
Now that we know why credit scores are important and how impactful and influential they can be in financial decision-making let’s look at some of the tips on how to improve them and keep the scores higher.
- Know your credit situation: Get your latest credit reports, keep track of all the credit-related information, and analyze your credit reports.
- Dispute error on your credit reports: Remove or dispute negative items that do not belong to you from your credit reports; this can be done by disputing them using 609 dispute letters.
- Pay smaller debts first: Smaller debts are easier to pay and show consistent progress on your credit reports.
- Pay on time: If you want to fix your credit score, paying on time is the biggest factor. When you fail to pay on time, the debt increases, and the credit score is directly impacted.
- Set the right credit limit: A right credit limit is a good practice to increase credit scores; your credit expenses should always be under 30% to reflect good financial behavior.
- Credit builder loan: It helps you to improve your credit score as the lender reports on-time payments while the money is sitting in your savings bank account.
- Authorized user to your account: Adding an authorized user to your credit report will give an instant boost to your credit score. But ensure the user does not have a poor or average credit score, or the results won’t be impactful.
- Maintain a long credit history: A long credit history always help in building a great credit profile and leaves a positive impact while securing a loan.
- Have an emergency fund: Emergency funds are the best way to keep yourself safe in times of bad credit situations.
Learn More – Space Shuttle Strategy, which helps you improve your credit scores and in detail explains how you can constantly maintain a good score in the future. It is so easy that you can fix credit scores on your own and run a successful DIY credit repair business as a side gig.
Frequently Asked Questions about Credit Scores
Credit scores can change monthly, depending on the information reported by creditors and credit bureaus. Factors such as payment updates, credit inquiries, and account changes can influence score fluctuations.
Closing accounts may impact your credit utilization and credit history length, potentially affecting your credit score. Before closing an account, consider the implications it may have on your credit profile.
Negative information, such as late payments or collection accounts, can remain on your credit report for up to seven years, depending on the type of information. Bankruptcies can stay on your report for up to ten years.
Checking your credit score through soft inquiries (e.g., by using free credit score services) does not impact your credit score. Soft inquiries are initiated by you for informational purposes. However, hard inquiries from credit applications can cause temporary score decreases.
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Wrapping up: Understanding Credit Scores
This pretty much wraps up our small guide on what credit scores are and how they create an impact on our lives. As an individual, you should know a few terms, such as soft and hard inquiries, how credit scores are calculated, how to obtain your credit scores, and what factors impact your credit scores. And if you are a little late, you can also start improving your credit history by using credit builder loans, clearing smaller debts first, on-time payments, and a few other factors, as mentioned in my handy “Space Shuttle Strategy” guide.
Also Read: DisputeBee vs Credit Repair Cloud | Which is the Best Credit Repair Software?
In this guide, I tried covering the basics of credit scores that one needs to know. However, there is more to it, which we shall understand in our future guided articles. Until then, do share this article and mention your views in the comment section.
