Go on any personal finance blog and you’ll see a lot of articles that discuss the notion of improving your credit score or improving your finances despite a poor one. This advice is great but forewarned is forearmed and in order to know how to improve one’s credit score, it’s a good first step to understand how your credit score is calculated. Thus, you’ll be able to gauge your credit score without carrying out a credit check (remember that carrying out numerous credit inquiries in a short space of time can, in fact, damage your credit score).
Your credit score is determined by 5 factors and it’s important to understand them to manage your finances effectively and make informed financial decisions so that your credit score is as favourable as possible. Sure, there are personal loans for people with bad credit on the market but there are some fields in which poor credit can impede your life choices. If you want to apply for a mortgage, for example, you’ll benefit from a working knowledge of how a credit score is calculated…
Not all lines of credit are rated equally in the eyes of decision makers in the financial services industry. The type of credit that an applicant holds is a factor in determining their credit score and some types of credit have a bigger impact than others. Mortgages, for example, have a greater impact on this than a personal credit card. This factor accounts for 10% of your credit score.
Your recent credit is the number that a lender agrees that you can borrow. This also accounts for 10% of your total score and changes incrementally with each line of credit taken up by the applicant.
You may be doing a great job of managing your debt right now, but don’t be surprised that creditors will want to look further back into your history. If you’ve defaulted on any payments over the past few years this could be a red flag. Your credit history accounts for 15% of your credit score.
Needless to say, the size of your debt is a pretty big factor in determining your credit score, making up 30% of your overall score but it’s not the biggest. The total debt includes everything from student loans to mortgages to personal loans and credit cards. Not only is the size of the debt taken into account but how quickly it’s paid off. Quickly repaid debts can really help your credit score. Thus, it’s rarely a good idea to select the cursed “minimum payment” option when applying for a new credit card as this will prolong the debt and make it much harder to pay off.
The most important aspect of your credit score (at 35%) is not in how much you borrow, but in your ability to pay it back. If you’ve ever wondered why you keep getting offered premium rate credit cards despite having racked up some sizeable debts, it’s likely because you’ve done such a great job of keeping up with your repayments. Every time you miss a mortgage or rent payment or are late on your credit card repayments, it impacts negatively on your overall credit score.
Now that you know what makes up your credit score, you’ll be able to make better informed decisions with your finances that will enable you to improve it organically.