Do you know that your credit score can directly affect your financial life? Credit scores - ranging from 350 to 850 – are calculated through a complex equation involving various financial factors. To put it simply, your credit score is a reflection of your spending patterns and the debts you may have. The higher your credit score, the more acceptable you are to employers, banks and insurance companies.
All people may not have a credit score. Credit scores are applicable only for those individuals over the age of 18 who have been using a credit card or a loan for a minimum of six months. That means, if you are below 18 years of age or if you have never used a credit card, you will not have any credit score at all.
Calculating The Credit Score
Credit scores are calculated using the formula called FICO formula developed by Fair Isaac Corp. Lenders get credit scores from the three important credit bureaus – TransUnion, Equifax and Experian. However, when individuals purchase credit scores from these credit bureaus, they get the proprietary scores of the bureau that can be strikingly different from the FICO scores available for lenders.
All three credit bureaus calculate your credit score based on the specified percentage of the following factors:
• Payment history (35%)
• Debt amount (30%)
• Duration of credit history (15%)
• New credit (10%)
• Kinds of credit currently in use (10%)
Moreover, since these three bureaus collect financial information from different sources, your credit score is likely to be different for each bureau. In short, your possibility of receiving the desired credit depends on which bureau a lender turns to for your credit score.
Why Are Credit Scores Important?
When you apply for a loan, a lender would obviously need to confirm your trustworthiness and repayment history. The lender then turns to any of the three credit bureaus to view your credit score. If you have a credit score of say 750, the lender will be happy to sanction you a loan with lower monthly payments and lower interest rates since the high score points to consistently good repayment history.
Conversely, if the score is just around 500, it signifies a history of missed monthly payments or delayed payments. In such a scenario the lender will consider you a high risk borrower and provide you the loan – but with higher monthly payments and high interest rates. In some cases, you may only get a lower loan amount or even get completely turned down.
Factors Affecting Credit Score
Now let us take a look into the factors that influence your credit score.
• Credit history: This component includes questions like – Have you ever had problems in paying back your past loans on time? Do you regularly turn to loans and delay paying them back? Have you filed for bankruptcy during the last few years? If yes, remember that these factors will be reflected in your credit report and thus result in a lower credit score.
• Current debt amount: Lenders pay special attention to the total amount you currently owe and the credit limits you have used. For instance, if you own a credit card that has a limit of $1500, it would help your credit score if you use only a percentage of this credit limit.
• Frequency of inquiries: Inquiries about your credit score every now and then can adversely affect your score. Lenders get uneasy when they notice that there have been regular inquiries about your credit score from different people. Lenders then assume that you are possibly incurring huge debts.
Although most people can get upset about their low credit scores, remember that such low scores do not mean the end of the world. Even if you happen to get a low score, remind yourself that the situation is reversible. Once you understand the factors behind your low scores, you can begin working on them and gradually watch your credit ratings improve.