Knowing the factors that impact the credit card calculation is the first step towards achieving your financial goals. While the exact algorithm might be a secret, most credit agencies rely on certain factors while determining the credit score. Let us know how credit scores are calculated and which factors matter the most!
How Credit Scores are Calculated: What Affects Your Credit Score?
Most credit scoring agencies use almost the same model to calculate your credit score. Here are the top considerations while calculating the credit score. Let us look at these in detail.
1. Payment History
Payment history is the most important component used by the scoring models. The first thing the creditors are interested to know is whether the borrower has the ability and intention to pay the debt. To know this, they look at the previous loans or credits of the borrower and check whether the same was paid on time.
If the payment is late and not paid within 30 days after the due date, it damages the credit score. If the borrower doesn’t pay after 60 and 90 days damages the score even more. After 90 days, the creditor may charge off the account and consider the same as a default. This causes a serious dent in the credit score and updates on the credit report. On-time payments, on the other hand, lead to a high credit score.
2. Credit Utilization Ratio
Simply put, a credit utilization ratio means how much you use out of the total available credit! Each credit account has a fixed credit limit. The more you use the credit from that account, the higher is credit utilization. If your credit utilization ratio is less and the percentage of your limit that you use is low, you will have a better credit score.
For example, if your credit card offers you a Rs.50000 credit limit and uses only $10000, your credit utilization ratio is only 20%. Credit scoring algorithms combine your total credit utilization by considering all credit accounts. If your total credit utilization is high for one account and low for another, it will still harm your credit. The experts believe you should not exceed 30% of your credit utilization.
3. Credit Length
Were you considering to close your old credit card? Well, take a moment and know that this factor – average age of loan/credit account also plays a role in calculating your credit score!
Remember that closed accounts are not part of the average age of your credit accounts. It is better to keep your oldest accounts open for as long as possible for a great credit score. If the old accounts are removed from the credit report, it decreases your average age of overall accounts and lowers the credit length. A lesser credit length means a low credit score.
However, some people are unsure of keeping the oldest credit account when it charges an annual fee. You have to decide whether it is worth keeping the account open and paying the fee or closing it for a little reduction in the credit score. If your annual fee is high, you may close the account. The damage to your credit is temporary. Consider asking your lender to provide you with a fee-free card.
4. Credit Mix
Credit scoring models also consider the type of credit accounts while calculating the credit scores. The credit bureaus favor borrowers who have multiple types of credit accounts. A healthy credit mix includes a combination of a few credit cards and installment credit-like loan accounts. For example, credit cards and other lines of credit are revolving accounts. Personal loans, car loans, etc., are installment accounts. Maintaining a balance of these account types can lead to a better credit score.
5. New Credit Application
Did you know that applying for a new credit generates a hard inquiry? A hard inquiry is a request made by the lender to the credit bureau about the borrower’s past credit behavior. Generating multiple hard inquiries can hurt your credit score. However, knowing that a soft inquiry does not upset your credit score is equally important. A soft inquiry is a request to check your credit report.
A hard inquiry impacts your credit score, though minor, which fades away quickly. However, many hard inquiries in less time can substantially harm your credit score.
Wrapping Up
The credit card issuers and banks use this score to approve the applicant’s credit card and loan requests. A low credit score may mean denial of the loan application. However, those with higher credit scores get it approved and are entitled to better interest rates.
To keep your credit score high, knowing how the same is calculated is vital. You can maintain your credit score and enjoy financial wellness using the information above. For more assistance, connect with duefactory.com.
Disclaimer: This article provides a general guide to the subject matter. You should seek specialist advice about your specific circumstances.
FAQs
1. How can I calculate my credit score?
Ans. Using the factors – payment history, amount owed or credit utilization ratio, credit history or length, new credit applications, and credit mix, your credit scores is calculated.
2. Which is the most important determinant of credit score?
Ans. Payment history carries the most weight. This is one of the best ways to determine the borrower’s reliability. It showcases whether you have paid your dues consistently and on time. You will have a low credit score if you have had payment issues.
3. How does credit length matter while calculating credit score?
The longer your credit accounts are active or open, the better your relationship with the lender! The lenders trust more on the person with a good credit standing for 20 years rather than risking with someone who has been around for only two years.
4. What does credit score not consider?
The credit report does not consider age, income, employment history, etc.
5. My credit score is low. What can I do?
If your credit score is low and you need assistance to increase or remove negative marks, contact Due Factory, a credit repair company.