How are credit scores calculated?
Most of us who have a basic understanding of loans and interest rates know that credit scores are extremely important. It doesn’t matter if you’re looking to apply for a personal loan, an auto loan, a student loan, or a home loan, credit scores play a huge part in the amount of money you will pay over the duration of that financing.
Given the major impact that credit scores have on our financial lives, shouldn’t we know exactly how they’re calculated? Unfortunately, regardless of how curious you may or may not be about credit scores, most rating agencies keep their formulas under tight lock-and-key.
Do we know anything?
While the exact credit score algorithms are kept secret, some of the agencies have hinted at what broad categories affect credit scores.
Credit scores are influenced by five main factors:
- Payment history
- Current debt
- Length of credit history
- Recent lines of credit
- Types of credit used
Payment history may account for up to 35% on your total score. A consumer who has kept current on their past payments and avoided any sort of delinquency will rank high in this category, and thus be more likely to have a good all-around credit score.
Current debt equates to 30% of your total level. If you have a lot of outstanding debt, you will see your credit score fall since more debt is usually telling of higher risk.
Length of credit history is worth 15% of one’s credit score. The longer the credit agency has had to gauge a consumer’s credit worthiness, the higher they will rank on this contributing factor. Similarly, if a consumer is young or just entering the financing world, the credit agency isn’t sure how credible they are, and cannot rank them high in this category.
Finally, new lines of credit (such as new credit cards) and the various types of credit somebody uses account for 10% each. Consumers with older lines of credit tend to be more stable and credible since the agency can see older credit lines’ history. Newer lines of credit, on the other hand, need time to establish credibility.
And even the types of credit carry weight, because they tend to be more consistent lines of credit, such as mortgages and long-term personal loans. They tend to be more credible than multiple credit card payments or short-term loans.
What if I don’t like my score?
If you’re reading this and know you don’t rank well in any of those categories above, there’s no reason to stress. Credit scores are in constant flux and, fortunately, they can always be corrected.
By requesting a credit report, you can look over the past financial mechanisms that are affecting your score. If anything looks incorrect, you can report those inaccuracies to the major credit rating agencies and they’ll look into it. Any information that truly is incorrect will then be removed and your credit score will rise.
If nothing is wrong with your report, then time will be your new best friend. Credit scores automatically correct themselves as time progresses, but with one catch: you must begin to borrow responsibly, which means making loan and credit repayments on time.
After you adopt responsible borrowing and repaying practices, you’ll start to see your credit score rising in no time.
Alex Gomory is a writer and editor for loans.org, a website dedicated to providing the public with informative articles on the lending industry. Read more of Alex’s writing at http://loans.org, or visit the site to find low interest rates on virtually any type of loan you may be in the market for.