There are many reasons why credit score is important for us. Credit score affects your loan affordability, the type of loan you’ll take, and your professional life. So, as credit score is very important for us, we need to understand our credit score and try to improve it.
How credit score is determined
Your FICO credit score is prepared to provide the lenders an estimation regarding your loan affordability. They’ll judge you as a consumer and decide whether or not to lend you the loan. The items on your credit report determine your credit score. The history of your financial accounts - that means, your credits, your debts, and your payment frequency, all of these items will determine your credit score.
Your FICO score is the key factor which will evaluate your creditworthiness to the lender. A FICO score is divided into five parts:
- Payment history
- Amounts owed
- Length of credit history
- New credit
- Types of credit in use
1. Payment history
Payment history shows all about your payments, it’ll clearly show your payment frequency and time. From a lender’s perspective, it’s the most important thing they’ll care about. Lenders want their money back within the due date.
Tip for improvement: Keep track of each creditor and their respective payment dates. You can set reminders for payment for each creditor. . If you miss any payment, contact the creditor as soon as possible and pay the bill. Try to settle the payments before this information reach to the credit bureaus.
2. Amounts owed
You need to determine how much you owe on different types of account. For example, loans like student loans will not bring down your credit score. But, high balance loans like credit card accounts might do that. , .
Tip for improvement: Pay down installment loans on time. . Keeping credit cards with zero dues is a great strategy for having a good financial health, but utilizing a small balance is best for your FICO score. Also, note that you can “carry a balance” without paying interest. “Balance” is defined by the amount on your statement when it’s reported to the credit bureaus, so you can report a small balance but still pay it off in full each month.
3. Length of credit history
FICO will look at your length of credit history. They’ll check for how long you are maintaining a credit account (the age of your oldest account), when did you last open a new credit account, and what is the average age of all your credit accounts.
Tip for improvement: . Also, don’t be afraid if you have just opened “new credit”. Try to aim at proper repayment. FICO will focus on your accounts and put emphasis on other scoring factors.
4. New credit
FICO keeps the record of every new account you open. Opening a new account means you are sending the message to FICO that you are looking for credit. If you do this frequently, it’ll be harmful to you. But, that doesn’t mean you can’t go for credit cards, home loans or other loans. The lender will make an inquiry about your credit. . Also, your score will reflect all inquiries made in the last 12 months.
Tip for improvement: If you need to shop for a new credit account, make sure you don’t apply for too many accounts. While taking out a home loan, try to get a rate lock so that you don’t have to face multiple rounds of inquiries.
5. Types of credit in use
FICO evaluates different consumers over their different types of account. These accounts are namely credit cards, different loans, mortgages, etc. FICO explains that those consumers who don’t have many items on their credit report, but wish to grow a decent credit score must look into this aspect. . If a consumer proves that he or she can manage a credit card well, FICO will “trust” him/her more and give higher priority than others.
Tip for improvement: Don’t try anything foolish, and don’t go for new credit accounts frequently. When you feel that you are prepared enough, open a credit card account and manage it responsibly. It’ll surely put a good impression on you and have a positive impact on your credit score.
More on credit: Credit Quiz - Check out whether or not you can score 10/10