February 13, 2024
By: Jennifer Floyd
Demystifying Credit Scores
Credit plays a pivotal role in our financial lives, influencing our ability to make significant purchases such as homes and cars.
However, understanding credit can be complex. To make it easier, we’ve broken down the basics of credit, covering everything from credit score ranges to practical tips for maintaining a healthy credit profile.
Understanding Credit Scores:
Credit scores are numerical representations of your creditworthiness. These scores provide lenders insight into the risk of lending you money. You’ve probably heard of the most commonly used credit scoring model, the FICO score. FICO scores range from 300 to 850.
Here’s a breakdown of the general classifications:
Very Good (740-799)
What Makes Up Your Credit Score?
Your credit score is composed of several factors, each carrying a different weight:
Payment History (35%): Timely payments on credit accounts are crucial for maintaining a good score.
Credit Utilization (30%): This is the ratio of your credit balances to your credit limits. Most creditors will suggest you aim to keep this below 30%.
Length of Credit History (15%): A longer credit history is more favorable, as it provides more data for assessing your creditworthiness.
Types of Credit in Use (10%): A diverse credit portfolio, including credit cards, Installment loans, and mortgages, can positively impact your score.
New Credit (10%): Opening several new credit accounts in a short period can be perceived as risky behavior.
Who Determines Your Credit Score?
Credit reporting agencies, such as Equifax, Experian, and TransUnion, gather and maintain the information that influences your credit score. They use this data to calculate your score using specific algorithms developed by companies like FICO or VantageScore.
How Are Credit Scores Calculated?
The exact formulas used for calculating credit scores are proprietary, but there are key factors that are considered universally important. The most influential are payment history and credit utilization. This is why it is so important to ensure you’re borrowing responsibly and making timely payments.
Ways to Keep a Good Credit Score:
Pay Your Bills on Time and in Full: Timely payments are the foundation of a healthy credit score.
Monitor Your Credit Report: Regularly check your credit report for errors and address any discrepancies promptly.
Keep Your Credit Balances Low: Aim to use no more than 30% of your available credit to maintain a positive credit utilization ratio.
Establish a Mix of Credit: A diverse credit portfolio containing credit cards, installment loans, and mortgages can positively impact your score.
Ways to Improve a Poor Credit Score:
Create a Budget: Establish a realistic budget to manage your finances more effectively and ensure timely payments.
Settle Outstanding Debts: Prioritize paying off outstanding debts to reduce your overall credit utilization.
Seek Professional Help: If your situation is challenging, consider consulting with a credit counselor to explore personalized solutions.