Your credit score is a 3-digit numerical representation of your creditworthiness. It is an integral part of your credit report that lenders, banks, insurance companies and other financial institutions pay attention to before they decide to approve your request in their organization or not.
It reveals the total number of open accounts in your name, your total debt rate & repayment history, the total number of credit cards you own, and other factors that measure your financial capabilities. Your credit score is used by lenders to evaluate your ability to pay back loans, and how timely you can do that. Where you have older loans (either repaid or not), your credit report reveals the frequency and timeliness with which you paid.
Usually, a credit score ranges between 300 (being the lowest), and 850 (the highest). As an individual, the higher your credit score, the better your chances of getting loans approved to you at favourable terms and interest rates.
As an individual, your credit score affects how much or little you stand to get when you apply for credits, as well as the interest rate you may have to pay if you are lucky to get approved. This is why it is referred to as the statistical analysis of an individual’s creditworthiness.
While there are different ways to measure your credit score, the most commonly used credit score model is that created by FICO (Fair Isaac Corporation). This model rates 300 to 579 as Poor, 580 to 669 as Fair, 670 to 739 as good, 740 to 799 as Very Good and 800 to 850 as Excellent. As earlier stated, the higher your credit score, the better for you.
Aside from lenders using it to set the credit limit on your credit card, your credit score may be used to determine how much you are required to pay upfront as an initial deposit for your cable service and other utilities while buying a smartphone, or when you are about renting an apartment.
The elements of your credit score
The 3 major credit reporting bureaus in the United States of America (Equifax, Experian, and Transunion) are responsible for calculating your credit score and inputting your credit report. For every financial related activity that you are involved in (loans, credit accounts, savings, insurance, mortgage, car hire/purchase), an updated report is sent to these agencies to notify them of these new activities so as to ensure that your current credit score and credit report reflect your true financial stand and are reliable for reference purposes.
While determining your credit score, the following elements make up the eventual outcome. They are;
#1. Your Payment History
Your payment history accounts for about 35% of your total credit score. It shows the frequency with which you paid back previous debts. So, it is regarded as the most important element of your credit score.
This element focuses on your behavior towards repaying past debts and is used to predict your behavior if future credits are approved for you. With your payment history, one negative comment is enough to blow your chances of getting the required financial assistance that you need at the moment.
Revolving credits like your credit cards and installment debts like mortgages are given special attention when calculating your payment history. As a result, the importance of consistent, on-time previous payments cannot be overemphasized. Just as the same approach is important for present debts when future applications are being reviewed.
One of the best ways to boost your credit score is to clear your debts and pay them up on time.
#2. The amount you owe
This is the second biggest element of your credit score as it accounts for 30% of your credit score. This element is also expressed under your credit utilization ratio. It compares the ratio of the credit that you use against the credit that is available to you.
Through this element, lenders are able to understand the level of your indebtedness at the moment. If the amount you owe appears to be too much, they may decline your application for new credit. This is so because they wouldn’t want to lend to someone that is obviously neck-deep in debt. If your credit suggests that almost all your monthly net income is to service debt, it is a red flag to lenders. They wouldn’t want to risk lending to you again.
Generally, for your credit utilization ratio to be considered as good, it should be 30% or less. This means it is better to not exceed 30% of whatever credit limit that is given to you. This explains why some people advocate for ownership and use of multiple credit cards. That way, you can split your expenses across all credit cards and maintain the 30% benchmark. Similarly, you can ask for your credit limit to be increased or be intentional about watching your spending and ensure that you do not cross the line.
If your credit score shows that you always reach or exceed your credit limit, lenders may see you as a potential risk and may avoid you.
#3. The Length of your Credit History
This is another important element of your credit score. As the name implies, it tells investigators (lenders, credit bureaus, banks, insurance companies, landlords) how long you have been using credit.
This element is particularly important because it makes it easier to determine your financial behavior. With this element, the longer the length of your credit history, the better for you. This is because your credit report will be filled with enough data to judge in your favor.
However, if you have been irresponsible in the past, long credit history can still be disadvantageous to you. This is because the same way it can provide lenders with enough information to consider your application, so also can it present them with enough information to have resentment against you if the report suggests concerns about your integrity as a result of how you have handled previous transactions.
This element is why older credit users are preferred to newer users as it may take the latter a while to accumulate enough convincing data as the former. This is also one of the reasons why people are advised not to close all their credit accounts. It is advisable to leave some of your credit lines open, even if you are not using them. Although, you will need to be careful not to get carried away and start spending unnecessarily.
Your credit history length makes up to 15% of your credit score.
#4. Your Credit Mix
Except in circumstances when your credit history is small, your credit mix is relatively minor as it accounts for about 10% of your credit score.
The credit mix shows investigators the several sources of your previous credits like credit cards, car loans, student loans, mortgages and others.
Also, it does not bother about how many credit cards you have opened but pays attention to your credit utilization ratio and how your repayment history is fairing.
The credit mix is also an indication of how you have been able to manage the different range of credit facilities that are available to you. This diversification can be a blessing or a curse. Depending on your previous performance(s).
Although having multiple credit lines opened in your favor is great for your credit mix, as it tells the lender that you are mature, not new to credits and can handle one more, it is best that you limit your credit lines to what you can handle. This is necessary so as not to dig a financial grave for yourself.
#5. New Credit
The remaining 10% of your credit score is determined by this element. It tells investigators your recent financial activities like opening new credit accounts.
If your credit report reveals that you opened multiple credit accounts recently while investigating a current application for another, it is a huge red flag that they cannot ignore.
The first question they may ask is why are you applying for multiple credit cards in such a short period? They may also suspect you of trying to beat the system by having as many credit cards opened as possible and lifting your credit score fraudulently.
For the sake of this element, if you are a borrower with a short credit history, it is not advisable to try opening multiple credit accounts within a short period.
Whenever you apply for a new form of credit, lenders’ checks of your credit score are also recorded. Therefore, if your credit report shows that checks are frequently carried on your report, it may also make investigators raise an eyebrow. They see an increased risk when they notice too many inquiries on your report. This is also capable of hurting your credit score.
Common activities that can hurt your credit score
Now that you know the major elements of your credit score, you need to be on the lookout for the following activities as they are capable of having a negative impact on your credit score;
When you miss payments
When you miss your monthly repayment of the debt as agreed, your credit score suffers. This is revealed in your payment history. This act is also considered as a deficit in integrity and no lender wants to risk their money with someone whose integrity is questionable.
Missing a month’s payment is in the same category as late payment. As little as one of such an occurrence on your payment history turns lenders away and has a negative impact on your credit score.
High credit utilization
When you use too much of your available credit, you scare lenders away and your credit score suffers. As it suggests that you are over-dependent on credit to lenders.
Lenders know this by comparing the credit you use vis-à-vis your available credit. Generally, it is advisable to limit your credit card spending to 30% of whatever limit you have been offered. If you have multiple credit cards, you can spread your expenses across all cards to maintain the 30% limit. If you have just a single credit card, be on the lookout for your spending so as not to exceed the limit. Remember, the fund in the credit card isn’t what you have earned yet.
Applying for multiple credits within a short period of time
Every time a lender makes an inquiry on your credit report, it is recorded- either the application ends up being approved or not. These inquiries can also be seen in your report within 24 months. Therefore, for every new request, the previous ones are seen. This may not appear too good in the eyes of the lenders. Why are you bent on opening these credit accounts? What is so important about being indebted? Why are your requests in the last 24 months always rejected? All these questions and more, begging for answers.
These multiple checks are also capable of drawing your credit score down for a while.
Lenders are particularly scared of multiple credit applications as it may suggest that you are on the verge of bankruptcy, in dire need of a way out with your ability to pay back as a source of concern.
When you default on accounts
Negative activities on your accounts like bankruptcy, foreclosure, charge-offs, repossessions, and settled accounts amongst others are not palatable to the ears and eyes of lenders. These activities could be signs of financial distress and lenders are not looking for who to help, but who to partner within the business.
The moment they notice any sign that suggests that a borrower would struggle to pay back, they will not hesitate to decline such an individual’s application. And remember, aside from the account activities being captured on your credit report, the lender’s inquiry is recorded too. And when the inquiries become one too many in a short period, they become causes of concern to future prospective lenders. All these contribute to a low credit score with the possibility of continuous decline.