Lenders check your credit worthiness when you apply for a loan or credit card. Worthiness in this case means your ability to pay or repay what is borrowed, based on your past payment history. This is often summarized in a three-digit score, called a FICO score, and is based on the Fair, Isaac and Company mathematical formula. FICO scores range from 300 to 850 with higher numbers representing a better credit worthiness.
Although not the only determining factor in whether or not you are able to receive credit, your credit score plays a vital role in the credit process. It contributes to the determination of the credit amount you qualify for, the rate you’ll be charged, and what terms you’ll receive. Higher limits and better rates and terms are generally offered to those with higher credit scores. Therefore, your credit score is an important contributor to your financial success.
Credit scores simplify and speed up the applicant review process for lenders, financial institutions, and insurers. These scores show you how you are viewed by the financial community at any given time. Keep in mind that they are fluid: meaning they may go up or down depending on certain criteria. This means you have the ability to improve or worsen your credit.
There are five factors that the score is based upon and each carries a different weight. Improving any of these factors will gradually raise your score.
The most important thing you can do to improve your credit score is pay your bills by or before their due dates. This factor represents 35% of your credit score makeup. Since the weight of this factor is the largest of all five, paying your bills on time can notably help you increase your score.
Representing 30% of your score is the total amount of debt incurred. A higher debt total is typically considered a negative, but not always. If you have a high income, assets, and a solid and timely payment history, a large debt may not be a strike against you. Also considered here is the relationship between how much you owe on credit cards and loans compared to your total available credit. Having a higher available credit balance has a positive effect on your score.
Representing 15% of your score makeup is the length of time of your credit history. Your score is improved by having a longer credit history.
Numbers Four and Five:
The variety of credit you have on record and the reduced number of new credit pursuits can affect your score. These two factors combined weigh in at 20% of your score. It is viewed favorably if your debt is from different types of credit, rather than just one. Such variety demonstrates your flexibility in obtaining and your responsibility in managing a variety of debt. In addition, not pursuing much additional credit reflects your ability to control your debt situation.