What Determines My Credit Score?

Your “credit score” is more than just a number. It represents your ability to borrow to buy the things that matter in your life, and even get a job. A great score can help you get a lower interest rate on a loan. A not-so-good score can saddle you with higher monthly payments.  A poor one can result in loan denials.

So, if buying a home, car, or any major purchase is important to you, understanding everything you can about managing your credit score is equally important.

What it is, who reports it and who uses it.

A credit score is a number that represents your creditworthiness.

Credit bureaus (such as Experian, Equifax and TransUnion) determine your credit score and history by regularly gathering information from your lenders (credit card companies, mortgage lenders and others). All information quickly shows up on your report!

The credit report maintained at these agencies lists all the credit accounts you have ever had, your payment history and your running credit score. Note: at your request, the bureaus will issue a free copy of your credit report yearly; checking for mistakes is a good idea.

Lenders want to be sure they are loaning money to someone who is likely to always pay on time. They use your credit score to evaluate their level of risk.  Employers often look at credit reports and scores as part of their hiring criteria.

So, you want to take action to maintain the highest credit score and cleanest credit report you can.

How is it determined? Five factors impact your credit score.

Payment history is easily the most important in determining your score. Late payments are credit score killers. Even one late payment can lower your score dramatically. Also, the type of payment matters. For example, late credit card payments aren’t as damaging as late mortgage payments. The answer: Make all your payments on time.

Debt-to-credit ratio – Your debt-to-credit ratio indicates how much of your available credit you are actually using. The ratio looks at the total debt you carry as well as individual accounts. High debt levels hurt you. For example, a credit card with a $1,000 limit and a balance of $500 equals an unfavorable ratio of 50%.

What you can do: For credit cards, lines of credit and other accounts you can control, don’t exceed 30 to 40% of your available credit. Control credit spending and pay down debt as quickly as you can, and you’ll improve this part of your credit score.

Length of credit history – The longer your credit history is the better. So, if you haven’t borrowed, it’s a good idea to build credit now and develop a solid score for big purchases in your future. Start with a small personal loan from a bank, or get a secured credit card. Keep the purchases small and pay them back on time – it will do wonders for your credit score.

Mix of credit – The types of credit and loans you have factor into your score. Credit cards alone don’t factor highly, while a varied mix of, say, credit cards, mortgage, and auto loans aid your cause. Your credit mix only accounts for 10% of your overall score, so taking out a lot of different types of loans to build your score is not needed and not recommended.

Recent credit inquiries – Your score will be negatively impacted if you make multiple applications for credit in a short period of time – this is statistically the sign of a distressed borrower who may be near default. So, you should apply sparingly, and also ask anyone who might check your credit (banks, employers, landlords, car dealerships…) and rack up inquiries not to do so unless really necessary.

Now you know Understanding how your score is determined and how it affects your finances, you’re ready to make decisions that work to your advantage.