What determines your credit scores?

What determines your credit scores?

The precise calculations that determine consumer credit scores are closely held trade secrets, but credit scoring companies share general information about what’s good or bad for your credit. Understanding how different actions can affect your credit could help guide you in building or rebuilding an excellent credit score.

Credit scores depend on your credit reports

Some large financial institutions develop their in-house custom credit scores. Additionally, FICO® and VantageScore® create the credit scores that most consumers are familiar with and regularly check.

FICO was one of the first companies to develop a scoring system based on consumers’ credit history, and it remains the primary scoring agency in the United States. VantageScore is one of its largest competitors.

Both companies develop generic credit scoring models (non-custom models that various lenders can use) based on information in consumer credit reports. If something isn’t in your credit report, it won’t impact one of these credit scores.

These generic scores predict the likelihood that someone will fall 90 days behind on one of their bills. The scores tend to range from 300 to 850, and higher scores are better–meaning the person is less likely to pay late.

Each generic credit scoring models has its unique formula for determining your score. However, they all tend to use similar scoring factors, which can be broken down into five categories:

Your payment history is the most important factor

Since credit scores predict whether you’ll pay a future bill on time, it may come as no surprise that your history of paying bills is an important factor.

Having a long history of making all your payments on time is best for your scores. An occasional late payment might hurt your scores, but it won’t necessarily keep you from having a high credit score.

The further behind you fall on a payment the greater the potential impact, though. Eventually, your account may be sent to collections, which could hurt your score even more. Public records related to your payment history, such as a bankruptcy, could also seriously damage your credit scores.

One interesting thing to note is that creditors have to report late payments in specific ways. They can say you were 30-, 60-, 90-, 150- or 180-days late. Your creditor may still charge you a fee if you’re just one day late, but because 30-days late is the first option for credit reporting, a late payment shouldn’t be on your reports if you were one to 29 days late.

Your current balances are also very important

Your current financial situation can also impact your credit scores, as you may have trouble taking on a new loan if you’re already paying other monthly bills. While your income is not a scoring factor, the amount of available revolving credit that you’re using is an important factor.

Let’s break that down. Say you have four credit cards, and each has a $1,250 credit limit. You only use one of the cards, and it currently has a $500 balance. In total, you’re using $500 of your $5,000 overall available credit, or 10 percent.

The ratio of your current balance to total available credit on revolving accounts (i.e., credit cards and lines of credit) is called your utilization rate. A lower utilization rate is generally best for your credit.

Your utilization rate on individual accounts is a factor, but your overall utilization rate could be more important. How much you owe on installment accounts, such as a student, auto, or home loan can also impact your scores.

One tricky point—your utilization rate depends on your account’s balance as it appears on your credit report, which might not be the same as your current balance.

Credit card issuers may report your account’s balance at the end of your card’s statement period, which is also when they send you the bill. You could pay your bill in full every month, never pay interest, and still have a 100 percent utilization rate.

Making early payments throughout the month could lower your account balance, leading to a lower utilization rate that may help your credit scores.

The length of your credit history

Credit scores may consider a variety of age-related data points, such as the age of your oldest account, the age of your newest account, the average age of all your accounts. Having a long credit history, particularly if it’s filled with on-time payments, could be good for your scores.

An account might stay on your credit reports for up to 10 years after its closed and continue to impact your credit history. If a closed account has a balance on it, the balance may also factor into your utilization rate. However, closed accounts without a balance aren’t part of that calculation.

Your experience with different types of accounts

The number and types of accounts you have can also impact your scores. Having a mix of revolving and installment accounts could show creditors you know how to manage different types of loans or monthly payments.

Certain types of accounts may play a more significant role in determining industry-specific credit scores. For example, some scoring models are creating for auto lenders, and your history with auto loans could be more important to those scores than to non-auto-lender scores.

Your recent credit usage

If you recently applied for or opened a new account, that could impact your scores in various ways: your utilization rate, age of accounts, and types of accounts could all change.

Additionally, a record of your application for new credit—called a hard inquiry—is added to your credit report. A new hard inquiry can sometimes lower your credit scores by a few points, and it will be added to your credit reports even if you didn’t get approved for the account. Multiple hard inquiries can have a more substantial negative impact, as that could indicate you’re scrambling to find financing.

However, it’s generally still a good idea to apply with multiple lenders and try and get the best rates and terms on a new loan. Credit scoring models recognize this is savvy financial behavior and let you shop for a loan without excessively hurting your scores. For example, if you apply for multiple auto, student, or mortgage loans within a 14- to 45-day period (depending on the scoring model), then only one of those hard inquiries will impact your score.

Errors in your credit reports could impact your credit scores

As mentioned above, your generic credit scores depend entirely on the information in one of your credit reports. Knowing this, you may want to periodically review your credit reports for errors and dispute incorrect information.

For example, if you were 10 days late on a credit card payment and the issuer reported your account 30 days late, you might be able to get the incorrectly reported late payment removed from your credit report. Your scores might rise as a result.

Want help reviewing your credit reports? With CreditDash you can upload your credit reports, and the software will automatically analyze your reports for potential errors. It will then help you create and mail letters to get the errors corrected.

Link to “What’s in your credit reports and how to read them”

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