Understanding Credit Scores: How Are Credit Scores Calculated?
Learn about the financial behaviors that affect your credit score
The more you know about how your credit score is calculated, the easier it becomes to build credit. A higher credit score means that your credit applications may be more likely to be approved and with more favorable interest rates. In some states, credit scores can influence how prospective employers evaluate job applications, how insurance companies assess risk, and how landlords approve rental applications.
Many mortgage companies and lending institutions rely on credit scores as a fast and reliable way to determine your credit worthiness. When viewing your scores, be sure to focus on what bureau is providing the data because there can be slight variations in the data contained in each credit report, as different credit scores are calculated in different ways. Additionally, small differences in scores, pulled at different times, are considered normal.
When you understand the basic formula, you can take simple steps that could ultimately result in a higher credit score.
This is typically one of the most significant components making up your credit score, because it shows lenders your track record for making payments on time and whether you’ve missed any payments. Paying your installment loans and credit cards on time is one of the ways you can maintain or improve your score. To help you along, take advantage of the automatic bill pay feature lenders offer, which could help you avoid late payments.
This is the ratio of your total available credit to the amount of credit used. Lenders will assume you are a higher credit risk if your revolving debt is high. A good rule of thumb is to keep your credit card balances as low as possible.
Length of Credit History
This considers your oldest account, but also the average age of all of your accounts. For this reason, you should avoid opening too many new accounts at once, especially if you have a short credit history.
This is measured not only by the number of new credit accounts you have opened, but also the number of credit report inquiries that are generated when you request a line of credit. The good news is that unsolicited “pre-approved” offers are considered “soft inquiries” and do not negatively impact your credit score. However, if you apply, the lender will make a hard inquiry. Knowing this can help you decide whether you should consider an attractive low-interest offer on a new credit card.
This considers the number of accounts you have and the types of accounts they are. Your score is typically improved by demonstrating a history of managing different kinds of credit, such as a mortgage, installment loans, and revolving lines of credit.
Now that you understand the score, the first step to achieving a better one is to obtain copies of your credit report from each of the major bureaus at www.annualcreditreport.com to help you learn what makes up your score. You are entitled to one free copy a year, after which a small fee applies for additional requests.