The factors on your credit report that are used to determine your credit score are broken down into 5 categories, each with it’s own weight on the equation.
1. payment history (35%)
2. amounts owed (30%)
3. length of credit history (15%)
4. new credit (10%)
5. types of credit used (10%)
One of the primary reasons that the credit scoring system was developed and why lenders still use it is to determine the likelihood that they will be repaid the money you borrow. Therefore, it makes sense that your payment history would be a mjor factor in your credit score. This aspect is affected negatively by late payments, accounts sent to collections, and bankruptcies. The more recently any of these have occured, the larger the effect on your score.
Outstanding debt is the next most important measure of your ability to pay back your obligations. Having credit cards, owning a home or car, or going to college means you probably have some debt on your record, which is okay. However, this part of your score can be affected by maxing out credit cards, or leaving them open with no activity. To quickly raise your credit score, pay off credit cards with the highest interest rate or where you have late payments first. It is good practice to keep credit cards at 25% of less of their balance.
Length of Credit History
The length of your credit history is based on the oldest account in your credit file. For many people this is their first credit card, a student loan, or possibly a car loan or mortgage. The shorter your credit history, the bigger the risk you represent to lenders. You should also be aware, however, that as your credit history gets longer and you have more accounts opening and closing, you are also at a greater risk for having misinformation added to your report.
10 percent of the score is based on new credit. Typically your score will go down for awhile after you have opened up a new line of credit. The major factor of this percentage comes from inquiries. There are two types of inquiries; soft and hard. A soft inquiry does not affect the credit score and usually involves a quick glance at your score. A hard inquiry does lower your credit score and typically is a result of actions initiated by you in an effort to obtain credit. If you open 2 new credit card accounts, take out a private bank loan, and attempt to buy a new car, your score will go down…the good thing is that your score will rebound from these inquiries.
Hard inquiries do affect your score, and lower it by a number of points for each inquiry. Hard inquiries are generally the result of you pursuing new credit opportunities. This is mostly a defense against you obtaining a good credit score and opening 100 new credit accounts all at once. After 10 inquires or so your score would be significantly lowered to the point where lenders would begin to reconsider your credit. The good news is that hard inquiries do not affect your credit for very long, and your score will return to normal after they expire.
Types of Credit Used
The final part of your score is based on the types of credit accounts you have. These include:
1. Revolving (credit cards, lines of credit, HELOC)
3. Public Records (bankruptcy, liens)
Some types of accounts can really help you score as long as you are paying them on time such as a student loan, car loan, mortgage, and credit cards. If you have ever had a public records such as a bankruptcy, tax lien, or a collection, your credit score is going to be negatively affected. Beware of companies that claim that they can remove a bankruptcy or a collection off your credit report. These items will eventually not be detrimental to your credit score so time often is the best answer for dealing with these actions in your credit history.
Some of the account types can contribute positively to your credit score as long as they are paid on time. For instance, student loans, home mortgages, or credit cards, if paid on time, can create very healthy credit. However, accounts like tax liens, collections, or bankruptcy will affect your credit negatively. If you have any of this second type of account on your record and you know it is inaccurate or fraudulent it is a good idea to contact a credit repair specialist to have it removed.
The bottom line in understanding your score is that lenders want to loan to people who know how use credit responsibly. After all, lenders only make money when people use credit, and when they pay it back. Therefore, if your credit history reflects that you make proper use of credit and pay back your obligations, your score will reflect this to lenders.
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