How is Your Credit Score Determined?

By Randall Orser | Budget

Your credit score has a big effect on your life whether you like it or not.  Credit scores or reports were once only used for lending decisions but now they can affect if you are approved for insurance, renting a home or even getting a job.  When applying for a loan a creditor will use a person's credit score to determine whether or not they will be accepted for a loan.  

What is a credit score and how can you make sure it is in good standing?  To know how to keep your credit score at a good number it is important to know what components make up your credit score.  These are History of Payments (35%) Debts (30%) Credit Length (15%) New Inquiries (10%) and Diversity (10%). The Beacon Score is the most popular version of the credit score and ranges between 300 and 900 points.  The higher score is the better generally over 600 is fair and 550 is bad.  This score is critical when applying for loans because it will determine the interest rate that you will get and whether you will be approved or not.

History or Payments (35%) - Lenders need to know that borrowers have a good record of paying their bills.  If a person has had collections, several late or missed payments or had declared bankruptcy it will severely hurt their credit score.  However if you have messed up in the past and have recently turned things around this will be reflected in your score.  More recent missed payments etc are taken more seriously than those in the past.

Debts (30%) - The more someone has borrowed and not been able to pay back efficiently the less chance they have of being approved for a loan.  The more credit is used to pay bills the lower a credit score will be. Credit consumption should be less that 35% (this is the amount owed compared to a credit limit, so it is not good to charge your credit cards up to their limit).

Credit Length (15%) - Your financial responsibility is evaluated over time. A longer credit history is better than a short one as it is a better indicator of your spending habits and ability to to pay back your loans.

New Credit Inquiries (10%) - A constant stream of credit inquiries will negatively affect your credit score.  Inquiries made in a year are considered in your credit score calculation and many applications for new credit can be seen as a sign of financial trouble and getting more and more into debt.

Mix of Credit types (10%) - Diversifying credit types is not a big influence on your credit score but it can demonstrate your ability to manage your finances.  

Your credit score will greatly influence your approval for loans, mortgages and lines of credit.  A good credit score will enable you to get better interest rates thereby saving you a lot of money.

From an article by Caitlin Wood

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President/CEO Number Crunchers® Accounting Inc. Learn how to just say stuff it to this bookkeeping thing with our 'Just Say: "Stuff It" To Bookkeeping program.