Everything You Need to Know About How Credit Scores Are Calculated

If you’ve ever gone to make a large purchase that requires a loan or applied for a credit card, you were likely informed that a credit check would occur. This check supplies a lender or company with information that can make or break their decision to loan you funds or approve you for a card.

However, understanding what this information is along with the nuances involved can be a confusing process. Let’s dive into how your credit score can have a major impact on your financial decisions in life.

What is a Credit Score?

As the primary metric for a person’s creditworthiness, your credit score is very important. This score is essentially a prediction of how likely you are to repay debt based on your prior credit behaviors. Measured and provided by the credit bureaus, most credit scores have a range of 300-850, with a higher score being better than a lower score.

There is a difference between consumer-facing credit scores and lender credit scores that you may notice if you ever request to see your own score prior to submitting a loan request. The main reason for this is that consumer checks often take pure financial factors into account, such as the loans you currently have and your payment history. Lender credit scores will also take your entire written credit history into account, which can positively or negatively impact the consumer credit score.

The Different Factors of a Credit Score

Credit scores can be calculated slightly differently depending on who is running the math, but there are five primary factors that will be considered:

1. Payment History: As one would expect, payment history is the biggest factor involved in the calculation. At 35% of your total calculation, on-time and in-full payments will positively impact this factor, whereas missed payments will hurt it.
2. Amount of Money Owed: Nearly as important is your credit utilization, coming in at 30% of your score. This is the value you currently owe compared to the total amount you could borrow at a certain point in time.
3. Length of Oldest Credit Account: The age of your oldest credit account will be around 15% of the total score.
4. Current Mix of Credit: At 10% of your score, the mix of credit you have will be factored in. This can include mortgages, credit card accounts, installment plans, and more.
5. Any New Credit: Finally, the last 10% of your score will be based on the number of new credit accounts that you have opened in recent history.

Tips for Improving Your Credit Score

• Avoid making any late payments on your debt, and try to pay off more than you need to each time payment is due
• Request higher credit limits with your credit cards, if you can handle it, as this will impact the total credit amount you have access to
• Pay your credit card at strategic times to keep your credit utilization below 30%
• Become an authorized user on another person’s credit card account
• Start your credit journey with a secured credit card where only a small amount of funds are released to you at a given time
• Report your rent and utility payments to the credit bureaus if this is an option in your unit
• Change up the types of credit you have by taking on a mortgage, setting up an installment plan, and more

Debt

is a major problem around the world, and a bad relationship with credit is a stepping stone toward debt. Stay on top of your finances to improve your options in the years to come.

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