Your credit score is extremely important as it affects the rates you pay on your mortgage, insurance, car loans, student loans and any other lines of credit and the maximum amount you may borrow. Lenders use your credit score to determine your “creditworthiness.” Creditworthiness is defined as the likelihood a borrower will default on payments toward a line of credit. If you have a low credit score, you will probably receive a higher interest rate on any line of credit you receive. Inversely, the higher your credit score, the lower your interest rate on a credit line. The three major credit bureaus, Transunion, Equifax and Experian, all use their own proprietary algorithms to determine your credit score. However, there are common similarities within the different algorithms and knowing these similarities will help you attain a higher credit.
The total credit debt you have accrued divided by your total available credit is called your “credit utilization.” The credit bureaus consider high credit utilization as a warning sign of credit risk. If you have high credit utilization, lenders assume that you are attempting to live off your credit while only making the minimum payments. Having credit utilization over 30% will cause your credit score to drop. Additionally, credit utilization is the highest weighted factor in most credit score modeling algorithms.
Every payment you make toward a line of credit is logged and reported to the credit bureaus. Making every payment on time is a strong indicator to lenders that you are responsible with your credit. Missing even one payment can decrease your credit score significantly.
The average age of your credit lines is a major component of your credit score. Many lenders believe that maintaining a line of credit for a significant period of time as a positive indicator of responsible credit habits. As such, never close a credit account that’s not in current use. Instead, keep the account active by periodically charge a payment to the account and immediately pay off the balance.
Your total number of credit accounts affects your credit score as it shows how many other lenders are willing to take a risk by extending you a line of credit. You’ll want to obtain a mix of revolving credit cards, mortgages, installment loans and other forms of credit to prove to lenders that you can responsibly manage any type of credit line.
Every time your credit history is pulled, a “hard inquiry” is placed in your file. This means a hard inquiry will occur any time you apply for credit. Hard inquiries stay in your credit file for two years. Lenders view a high number of hard inquiries as an indicator of your desperation to obtain a line of credit and will view you as a potential credit risk. To avoid having a higher number of hard inquiries, only apply for credit you need. Note that pulling your own credit through a credit monitoring service results in a “soft inquiry” and has no affect on your credit score.
Maintaining a healthy credit score is essential in today’s society to obtain desirable prime loans. Understanding the various factors that comprise your credit score is key to accomplishing this goal. With due diligence and responsible actions, you can attain a high credit, which in the long run will greatly pay off.