Credit ScorePersonal Finance
The accessibility of consumption or investment loans depends strongly on your credit score. Your credit score determines your interest rate and co-signer requirements. Over the course of years, credit score has a significant impact on your cash outflows. This number comes from your history of handling debt obligations. Each time you engage in a credit related transaction a record is sent to multiple tracking organizations known as credit bureaus. They combine data from credit transactions into a document called a credit report. Each credit bureau has a slightly different version of the credit report, and lenders often access different companies or a combination of reports. Since they can look at any bureau’s report it’s crucial to know all your possible scores.
The three credit unions are separate companies. The first is known as Equifax, which calculates the Beacon credit score. The second is Experian, which calculates the Experian credit score. The third is Transunion which calculates the Emperica score. Americans are legally guaranteed a credit report from each credit scorer each year. They can purchase additional reports afterward. Loan application responses will sometimes openly state your credit score, especially if it’s cited as a reason for denial.
The credit scores themselves are scored in a fairly standard triple digit scoring system. This system ranges from a low end of 300 to the upper end of 850. The low end of 300 represents the lowest rating possible; the upper end of 850 represents the highest possible credit. A score above 700 is considered great, between 600 and 700 is considered average, and below 600 is considered poor. Since the score determines your interest rates and future cash outflows it’s always worthwhile to increase your score.
The credit score itself consists of enough factors to make one’s head spin, but they are fairly simple. There are five basic determinants of your credit score focusing on your previous handling of debt. They’re only debt based. It does not include your profession, job location, investment assets, or income. Each score is calculated from a specific mix: Payment Accuracy is roughly 35% of your score. Total Debt is roughly 30%. Credit History is roughly 15%. Recent Credit applications are roughly 10%. Finally, Types of Credit borrowed is roughly 10% of your credit score.
Your payment history is 35% of your credit score and indicates your ability to make payments on time. It’s the largest part of your credit score. Any payment, even minimum payments, will raise this section of your credit score. Even so, note that this section includes the amount of your last payment compared to the debt level.
It’s highly recommended you make frequent payments to raise this section of the score. You should avoid any late payments, even if you pay less than the minimum payment.
The amount of debt you owe others makes up 30% of your credit score. Your total debt is related directly to the overall amount of debt you can acquire. The score is calculated on a ratio of debt used versus debt available. Lower debt available will actually hurt your score. It’s wise for you to keep your credit accounts open since cancelling them will reduce your available credit. Simply cut up the cards to prevent actually using them.
The actual length of your credit record counts for 15% of your credit history length. Longer credit history will acquire higher scores for this category if it’s a quality credit record. This section takes the age of your highest credit accounts and assigns higher scores for longer records. When two records of otherwise equal credit quality are compared, the longer credit history will receive a higher score.
Some lenders will actually cite insufficient history for credit denial. Since the age of your credit accounts determine your score, it’s unwise to close accounts that you’ve had for a long period of time. This will lower your credit age and lower your score.
Types of Credit
The various types of credit you have affect 10% of your credit score. Specific types of debt will change your score as well. If you have $40,000 of debt with $30,000 in student loans and $10,000 in credit card debt, you will have a better credit rating than someone with $35,000 in credit card and $5,000 in student loans, all else equal. The credit card debt is riskier than the student loan debt or mortgages. Despite those being the same amount, the category of debt strongly affects score ratings.
The final 10% of your credit score is determined by your applications for new credit. Why would new applications for credit be seen unfavorably? Those are financially challenged or suffering hardship typically are the ones who need the most credit. They will be the first to apply.
Credit bureaus punish you for applying for more credit, but they only punish you in a specific way. Every time you apply a mark is placed against your credit score. This mark is labeled as an “Inquiry”. However, only the first inquiry within a time frame is marked, so if you make several inquiries within a short time frame only one inquiry will appear. The trick is to make many applications for a credit card or loan at the same time. Make all your applications within roughly one to two weeks when seeking credit.
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