5 Factors that Affect Credit Scores
Credit scores are valuable because they can help with our financial goals or provide financing when we need it the most. The calculation of credit scores is actually quite basic. If you understand what goes into the calculation, you can manipulate the factors to your advantage. Let’s learn more about how credit scores are calculated and what factors affect credit scores below.
How Are Credit Score Calculated?
In America, there are three credit bureaus: TransUnion, Equifax, and Experian. These credit bureaus are responsible for collecting data about consumers, calculating a credit score, and providing credit score information to lenders.
Because they are independent institutions, they have slightly different methods of calculating credit scores. However, your credit score should only be off by a few points when comparing the values between all three. This is because all credit bureaus consider the same information when calculating your credit score, which is as follows:
● Payment History: Your historical record of paying lenders.
● Credit Utilization: The amount of credit you’re currently using compared to what’s available to you.
● Credit History Length: How long you’ve been using credit.
● Inquiries: When someone pulls your credit report other than you, an inquiry is recorded.
● Credit Mix: The different types of credit you’ve used in the past and are currently using.
Factors that Affect Credit Scores
Now that you know more about credit scores and how they’re calculated, let’s assess factors that affect credit scores. Ultimately, everything goes back to the five factors that go into a credit score calculation.
Timely, Full Payments
Payment history has the biggest impact on your credit score. When you always pay your debts on time and in full, you will notice a positive effect on your credit score. On the contrary, when you fail to pay your debts on time and in full, you will notice a negative effect on your credit score
Amount of Debt You’re Using
Let’s say you have one credit card with a $1,000 limit and your current balance is $950. Your credit card is essentially maxed out. If you were to run into an unexpected expense, you’d have difficulty covering it, especially if you haven’t fully paid off your debt in a long amount of time.
For this reason, lenders like it when people use a lower percentage of the debt that is available to them. You will be more financially resilient this way and your credit score will increase when you keep credit balances low.
The longer you’ve been using credit, the more information potential lenders will have available to them. The longer your credit history is, the better your credit score will be.
This factor can be difficult to control because it’s not like borrowers can go back in time and open a credit card account sooner. Although, don’t close your accounts, even if you’re not using them. They will remain on your credit report and benefit your credit score.
Amount and Frequency of Inquiries
Inquiries occur anytime someone other than yourself pulls your credit report. In the eyes of the lender, the higher this number is, the more desperate it appears you are for financing. When borrowers are desperate for financing, they are more likely to default because they’re already in precarious circumstances.
The lower and less frequent your inquiries are, the better your credit score will be. Of course, there will come a time when you want to apply for financing, so don’t let this factor hold you back too much! Consider applying for new credit in waves, many at the same time, and then none for a while.
Diversity of Credit Available
A presumption that is made with credit scores is the more types you can manage at once, the more impressive it is. So, when you have various types of credit that you’re currently managing and using, your credit score will improve.
However, proceed with caution. If you can’t afford to have a mortgage, car loan, five credit cards, and a line of credit, then don’t open those accounts. This factor doesn’t make up a big portion of your credit score. It’s more important that you can manage the debt that you have already.
Factors that Don’t Affect Credit Scores
It’s just as crucial to understand what factors don’t affect credit scores as it is to understand what factors do affect credit scores. Below are factors that do not impact your score.
● Marital status
● Where you live
● Employment history
● Support payments
What Your Credit Can Do For You
Credit is a powerful financial tool because it can help you achieve your financial and life goals, such as buying a house or car. The goal with credit scores is not to have it be the highest at all times, but to have your credit in a position where it can be elevated and used for your goals when you need it. Be mindful of the damage certain actions can have on your credit score to ensure that you’re always in a good financial position.