If you've ever applied for a loan, a credit card, or a mortgage, you probably know that your credit score is one of the most important factors that lenders consider. But do you know how your credit score is actually calculated? In this blog post, we'll explain the basics of how credit bureaus generate your credit score and what you can do to improve it.
Your credit score is a three-digit number that summarizes your credit history and reflects your ability to repay debt. The most common type of credit score is the FICO score, which ranges from 300 to 850. The higher your score, the better your chances of getting approved for credit and getting lower interest rates.
Your FICO score is based on five main categories of information from your credit reports, which are records of your borrowing and payment activity. These categories are:
- Payment history (35%): This is the most important factor in your credit score. It shows whether you pay your bills on time and how often you miss or are late with payments. Paying on time and avoiding delinquencies can boost your score, while late or missed payments can lower it.
- Amounts owed (30%): This factor measures how much of your available credit you are using, also known as your credit utilization ratio. It compares the total amount of debt you have to the total amount of credit you have access to. For example, if you have a credit card with a $10,000 limit and a $2,000 balance, your credit utilization ratio is 20%. Generally, the lower your ratio, the better for your score. A high ratio can indicate that you are overextended and may have trouble paying back your debt.
- Length of credit history (15%): This factor considers how long you have been using credit and how old your accounts are. It takes into account the average age of all your accounts, as well as the age of your oldest and newest accounts. A longer credit history can help your score, as it shows that you have more experience with managing credit. However, you can still have a good score with a short credit history if you demonstrate responsible credit behavior in other areas.
- Credit mix (10%): This factor looks at the variety of credit types that you have, such as credit cards, loans, mortgages, etc. Having a diverse mix of credit can benefit your score, as it shows that you can handle different kinds of debt. However, this is not a major factor and you should not open new accounts just to improve your mix.
- New credit (10%): This factor considers how many new accounts you have opened or applied for in a recent period of time. Opening or applying for too many new accounts in a short span can lower your score, as it may indicate that you are in financial trouble or taking on more debt than you can handle. However, this effect is temporary and your score will recover over time if you make timely payments and keep your balances low.
As you can see, your credit score is generated by a complex algorithm that takes into account many aspects of your credit behavior. The good news is that you have some control over your score and you can improve it by following some simple tips:
- Pay all your bills on time and in full every month. This will help you build a positive payment history and avoid late fees and interest charges.
- Keep your credit utilization ratio low by paying off your balances or reducing your spending. Aim to use no more than 30% of your available credit at any given time.
- Maintain a long and stable credit history by keeping your old accounts open and active. Don't close accounts that you don't use unless they have annual fees or other costs.
- Apply for new credit only when you need it and space out your applications over time. Avoid applying for multiple accounts in a short period or shopping around for the best rate too frequently.
- Check your credit reports regularly and dispute any errors or inaccuracies that you find. You can get one free copy of your report from each of the three major credit bureaus (Equifax, Experian, and TransUnion) every year at www.annualcreditreport.com.
By following these steps, you can improve your credit score and enjoy the benefits of having good credit. Remember that building or repairing your credit takes time and patience, but it's worth it in the long run.