Many people mistakenly think that their financial life’s most important aspects are how much they make, spend, and save. However, one important factor that no one should downplay is the credit score. Your credit score determines if you’re eligible to borrow money, and how much money you can be lent.
Most financial institutions and lenders all check your credit score to determine how much they should lend you, as well as the interest rate. Most people don’t know that, sometimes, even insurance companies, employers, and landlords may check your credit score to see whether you’re financially responsible.
There’s a lot of misinformation about what factors affect credit scores. This article looks at three vital factors that you should be mindful of.
1. Payment History
Payment history is one of the most vital credit score factors. Every time lenders give you a loan, the one question that always stands out is whether you’ll pay. No one wants to lend money to someone who won’t repay as agreed, even if you know them personally.
Your payment history makes as much as 35% of your credit score. A factor that’s also considered in your credit score is the pattern of your late payments. For example, if you delay a payment for 60 or 90 days, it will have more of an effect on your credit score than being late for 30 days, which can significantly drop your credit score by 90 to 110 points.
Some financial institutions may also fail to report your late payment to the credit bureau until you delay for 30 days. Nonetheless, you’ll be fined a late fee.
When deciding whether the late payment should affect your score, the bureau considers things such as how late you were, how much you owed, how many times you missed the deadline in the past, and how recently you’ve missed the deadline.
If you want to remain in good standing, the best thing is to avoid any late payments on all occasions.
2. Length Of Credit
How long you’ve held your credit also affects your credit score. Without a credit history, lenders have no way to tell if you’re responsible for your debts and how long you can take to repay the debt in full. Your credit history is important as it accounts for 15% of your credit score.
The factors considered in your credit history include:
• How old are your oldest and newest accounts?
• What is the average age of all your accounts together?
• When did you last use your accounts?
Keep in mind that while a long credit history can be helpful, it has to have an impressive record. This means it shouldn’t be flawed by late credit payments and other bad records. Also, a short credit history without late payments and not much in debts can be helpful.
This is why it’s always recommended to leave your credit card accounts open even when you’re not using them as the age of the account will be helpful for your credit score. If you close your oldest account, you’ll notice a decline in your credit score. If you have multiple credit cards, you can also consider balance transfers.
3. Amount You Owe
Generally, people with larger debts have problems repaying them fully. How much you owe and to how many creditors make up 30% of your credit score.
More importantly, your credit score is affected by your credit utilization. This rate is the ratio between the total balance owed and the total credit limit on all revolving accounts. In layman’s terms, your credit utilization rate measures the percentage of the total amount you’ve borrowed and how much you’d borrow if you needed to.
Generally, the most important components to look at are the following:
• How much of your total credit available have you used?
• How much do you owe on specific accounts, such as mortgage or credit cards?
• How much do you owe in contrast to the original amount in the installment accounts?
An example of how the credit utilization rate affects your credit score is if you have a limit of USD$500 and a credit card balance of USD$50, you have a credit utilization ratio of 10%. This way, you will look more responsible than someone with a higher credit utilization ratio.
The rule of thumb is to keep your credit utilization ratio less than 50%. Also, avoid having unpaid debts on numerous accounts.
Your credit score is important as it determines whether you’re eligible for loans, how much you can be lent, and the interest rates. You don’t need to have formal credit training to know what affects your credit score. In general, your credit score is affected by your payment history, the total amount you owe to lenders, and how old your credit history is.