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By Tracy Scott
Credit scores can impact your ability to obtain a mortgage or auto loan, open a business and even your ability to secure your dream job. At some point, your prior use of credit will affect your financial well-being. But, what is a credit score? A credit score is a three-digit representation of your likelihood to repay your debt obligations and is viewed by creditors as a measure of financial responsibility.
The methodology behind the calculation of the score will vary depending on the credit bureau and credit scoring agency used to generate the score as well as the type of creditor requesting the score. FICO® and VantageScore are the most commonly used credit scoring agencies.
Each credit scoring agency uses a different scoring model, but they analyze similar credit scoring risk factors. Regardless of which scoring model is used, individuals with no credit history are viewed by potential creditors as a higher risk since they have not demonstrated an ability to manage debt responsibly. Models vary on the weight each factor is given and what a numerical score indicates.
Generally, creditors seek to reduce their risk by granting approvals to potential borrowers with high credit scores or by offering a higher interest rate and less desirable terms to those with lower scores.
Whether you pay your bills when they are due or have the occasional late payment, future creditors want to know about it. Payment history is a crucial indicator of financial risk for creditors. Not surprisingly, they expect borrowers to make payments as promised.
On-time and late payments are both reported to credit bureaus. Depending on the scoring model used, payment history can also be influenced by how much was owed, how long ago the debt occurred, and to how many creditors.
Pro tip: Make payments on time to increase your credit score.
There is such a thing as too much credit. Too many credit accounts or credit accounts at or near credit limits can negatively affect your credit score. For instance, since credit balances are reported to credit bureaus each month, potential lenders might shy away from extending additional credit fearing you might not make payments if you incur additional debt obligations.
Keep your credit utilization ratio below 30 percent. This means that if you have a $10,000 credit limit, avoid carrying a balance of more than $3,000.
Your credit score can improve with age. A long history of on-time payments works in your favor. Old and new credit accounts matter as do the average age of all of your credit accounts.
Don’t close accounts you haven’t used in a while. Closed accounts will eventually fall off your credit report along with the associated good repayment history. Some creditors will automatically close an account for inactivity. So, if you have a credit card you haven’t used in a while, use the account for a one-time purchase every so often. Just be sure to still have automatic payments set up so you don’t miss a bill.
Opening new credit accounts is the most common way to build credit but too many new accounts at one time can indicate to a potential creditor that you might be a risky borrower. Proceed with caution. Only open up accounts that you need. New credit accounts lack the demonstrated payment history to positively affect your credit score and they lower your overall account age.
A variety of credit accounts is a factor in determining your credit score. Even though the repayment of a debt obligation is typically the primary indicator of creditworthiness, the following types of credit positively impact your score since they can demonstrate your ability to handle different repayment terms:
Data reported to one or more of the three national consumer credit reporting bureaus is what influences your credit score:
You first have to know what’s in your credit report in order to improve your credit score. Request a free copy of your credit report from AnnualCreditReport.com.
There are several ways to check on your credit score.
Check out some of our help tips:
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