Understanding your credit score isn’t rocket science, but something that anybody can master. It’s in one’s best interest to know all there is to know about this issue as it will affect a big portion of your life. Credit scores are an essential part of personal finance that can directly impact your ability to borrow money or even secure certain essential services.
There is a role financial experts play in our lives. But it is also incumbent on every individual to understand how credit score works, and how we can perform the system to, hopefully, have better financial outcomes. You don’t want to – pardon the pun – score an own goal as far as your finances are concerned.
In this article, we will delve into the often-overlooked factors that affect your credit score, providing you with crucial insights that could mean the difference between rejection and approval.
Whether you are a seasoned finance enthusiast or a young professional starting your credit journey, this guide covers all the key factors that shape your credit score.
Payment history is just that: making timely payments, on everything you purchase, all the time. It takes financial discipline to do that. Part of that discipline means making sacrifices and adopting better spending habits.
In the marketplace, lenders will judge you by your history and not by your potential. And your history is all there for them to read and make decisions that will affect your life. As they say, choices have consequences. If your financial choices have, for instance, caused you to default on payments, the consequences will be reflected in your credit score and will affect your lending decision.
Payment history makes up 35% of your total credit score and is the single most crucial factor that affects it. That’s why making on-time payments is essential to maintaining a good credit score. Any late payments can have a significant negative effect, resulting in a lower credit score.
Furthermore, your payment history can immediately impact your credit score. If you make a late payment, it can lower your score within 30 days. This credit report is made available by credit bureaus to all lenders and will affect every financial application you are making. Lenders perceive this as negative information and will not want to take any lending risks on you.
Your credit card is intrinsically linked to your payment history, one of the most significant factors influencing your credit score. When you use a credit card, every payment or missed payment is recorded and reported to credit bureaus, which then collaborate to curate your credit history.
Your credit card represents financial liberty, providing you the convenience to transact and shop at will. However, this ease and flexibility should not be confused with reckless spending, because it simultaneously brings with it the responsibility of maintaining a good credit score.
So, how does this happen? When you make a purchase using a credit card, you are essentially borrowing money from the credit card issuer, like a bank. Every financial interaction you have with your credit card contributes to your credit history; from paying off your outstanding balance on time to dealing with credit card debt, and more. This credit history is later used to calculate your credit score.
In simple terms, the way you manage your credit card responsibilities makes a considerable difference to your credit score. Hence, paying your credit card bills on time and maintaining low balances can help to establish a favorable credit score.
Credit utilization measures how much of your available credit you are currently using. A higher utilization rate can lower your credit score, while a lower rate will usually improve it.
Financial experts often recommend keeping this rate below 30% for ideal credit score maintenance. The lower your credit utilization rate, the better it is for your credit score, as it indicates that you’re effectively managing your available credit. Understanding the role credit utilization plays in your credit score calculations can assist in maintaining or improving your overall credit health, which is crucial in securing future credit or loans.
The short answer is everything. Why? Because it is your credit score that decides if you are worth the risk. And your credit score gets this vital info from credit bureaus, which tabulate your payment habits using your credit card as the metric.
For instance, if you have a total credit limit of $10,000 and you’ve used $3,000, your credit utilization ratio is 30%. Lenders often consider a lower credit utilization ratio desirable as it indicates you manage your credit well.
High utilization can lead to a lower credit score as it may appear you’re heavily reliant on borrowed money. Therefore, it’s imperative to monitor and manage your credit card balance to maintain a healthy credit score.
Having a long credit history is an important factor in your credit score. The longer your credit history, the better it is for your credit score as it shows potential creditors that you have a history of responsibly managing debt over a long period.
A longer credit history helps to increase the average age of your credit accounts, which is an important factor in your credit score. It can also strengthen your credit score by showing creditors that you can successfully manage debt over a longer period.
Many of us are not aware of how our credit score can be affected by the decisions we make. One factor that can hurt your score is applying for new credit.
Each time you apply for new credit, your current lenders are alerted. It can cause them to think you are over-extending yourself financially. This can result in your credit score dropping by a few points or remain unchanged.
Do this little exercise. Walk in your lender’s shoes. Imagine a borrower seeing applying for new credit, while the credit bureau is informing you they are overstretching themselves financially. As a lender, you are in business. You are looking at the bottom line. What decision will you make?
Here’s the thing. This does not mean you should never apply for new credit. It’s all about balance, though. Too much credit is bad for your score. You should only apply for new credit when you need it and be aware that it may have an impact on your score.
Having a mix of credit cards, installment loans, car loans, and other types of debt can show lenders that you are capable of managing multiple types of debt. On the surface, it may seem that having a myriad of debts doesn’t look good for you.
However, astoundingly, the scenario can play out differently. That’s why it’s vital to be aware of how different credit types can affect your score. Indeed, having a diverse portfolio of credit, which can include various credit cards, and installment loans such as mortgages, personal loans, car loans, and even student loans, can be beneficial. It serves as proof to potential lenders that you are capable of effectively managing and maintaining multiple forms of debt.
Credit bureaus that calculate your credit score identify this as a ‘credit mix.’ Your credit mix contributes to around 10% of your overall FICO credit score – one of the most commonly used credit scoring models.
When you display a record of punctually repaying several forms of credit, you depict financial responsibility and reiterate your reliability as a borrower. This diversity acts as a strong reassurance to lenders, providing them with greater confidence that you can successfully manage varying types of loans and make payments on time. However, this doesn’t mean you start opening numerous credit accounts in a spree to improve your credit score. Each credit type should be undertaken based on your financial needs and your ability to make consistent, timely repayments.
It’s never about accumulating the most credit, but rather showcasing your capability of managing and repaying your debts efficiently.
The journey to building an excellent credit score is not a dash but a marathon. It’s a process and not an event.
It takes wise credit decisions and sound financial management conducted over time to produce a favorable credit mix and, ultimately, a healthy credit score.
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