Credit Score and Factors Used to Determine It
A credit score indicates the creditworthiness of a person and is based on a number of factors. It considers both negative and positive information, and the factors taken into account have different weight. These are:
• Types of loans/revolving debt used (10 percent)
• New loans (10 percent)• Length of credit history (15 percent)
• Amounts owed (30 percent)
• Payment history (35 percent)
It can be seen that payment history (whether the borrower makes timely payments) has more weight than other factors. Payment history shows if the borrower has accounts that have gone to collections. In case there are late payments, it matters whether the borrower is 90 or 30 days late. The payment history of borrowers also shows if they have any garnishments, foreclosures, bankruptcies, and debt settlements. The amounts owed by borrowers are also an important factor. These include types of accounts such as student and car loans, business loans, and mortgages. How much a person owes on a mortgage or auto loan is taken into account. The credit score also considers outstanding balances, limits, and the number of cards a person has. The total amount of debt is another factor that plays a role. Length of credit history and the age of the borrower’s accounts also have impact on his credit score.
Types of loans and new credit are two other factors. The score considers the number of new accounts that borrowers have. People who have opened many accounts are considered to be credit risk. This may mean that they have financial and cash flow problems or excessive debt load. Hard inquiries by potential lenders are also penalized. These are different from soft inquiries whereby borrowers check their score. Note that these factors vary, based on whether a person has a long or no history. Having loans and account balances doesn’t mean that a person is a risky borrower.
Factors That the Credit Score Ignores
Your score is not affected by factors such as employment history, employer, and income. While financial institutions take into account length of employment, income level, and occupation, the credit score is not affected by them. Other factors include residence, age, child support, marital status, and national origin. The score also ignores factors such as rental agreements, receipt of public or social assistance, and whether the borrower participates in a credit counseling program.
How to Improve Your Score
There are some steps that help borrowers to build or rebuild credit and improve their score. It is important that borrowers check their credit utilization ratio. The latter is calculated by dividing the outstanding balances by the limit on each credit card. If the balance on one card is $2,500, the balance on another is $2,200, and both cards have a $6,000 limit, the ratio is 37 percent. Experts recommend a ratio of up to 15 – 25 percent of the borrower’s credit limit. Another way to improve one’s score is to make timely payments. Even if you are late, being late more than 30 days can seriously affect your score. Borrowers who plan to buy a vehicle or house or make other major purchases should check their score several months in advance. Thus they will have enough time to build credit and correct errors, if there are any. Finally, having a mixture of different types of debt helps improve your score. It is recommended to have experience with installment loans and revolving debt in the form of credit cards and lines of credit.
The information kept in your file is compared with the performance of borrowers with a similar profile and credit history. The bureaus use different scoring methods and systems such as the FICO Risk Score system and BEACON.
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