A credit score can be described as a numerical expression used by most lenders such as banks and credit card companies to ascertain a person’s creditworthiness. This is usually based on the analysis of the individual’s credit files. A credit score is primarily derived from the credit report information gotten from credit bureaus.
A credit score usually has a significant effect on a person’s life. In the past, credit score was only used to determine a person’s worthiness by lending institutions, but, nowadays, it is used to ascertain whether one gets a job or an insurance cover.
Getting to know how to calculate a credit score and the extent to which it affects a person’s life can help an individual to keep it in constant check and monitoring so he/she can be able to apply for future loans and insurance easily.
Credit Score Ingredients
- History of Payments 35%
- Debts 30%
- Credit Length 15%
- New Inquiries 10%
- Diversity 10%
The beacon score which is the most popular version of a credit score is generated by the Equifax Credit Bureau and determined using a complex algorithm, and the score ranges from 300 to 900. A high score of 600 and above means a good rating while 550 and below is bad. It gives the lender an insight into the borrower’s credit history and the potential ability to repay the debt.
The score is also used to determine the interest rate applicable, and the success of the application when applying for loans / bad credit loans. Below are the significant factors used to ascertain the beacon credit score.
History of Payments (35%)
Credit card payment history determines about 35% of the total credit score. A person who has several records of missed payments, and had been declared bankrupt will have a very low credit score when compared with someone’s that has a clean record. When applying for a loan, lenders will be wary of lending you money if the likelihood of repayment is not certain. A record that shows an overall good credit history with prompt payments recently can outweigh one or two cases of late credit card payments in the past.
However, it’s important to know how late payments can reduce your credit score, and exercise caution so as not to default every time. Remember that late payments usually reflect on your report for about seven years, and even some bankruptcies may reflect for a period of 10 years on your profile.
The probability of any loan repayment drops as a person’s debt profile increases. A high credit consumption utilized in bill payments usually leads to lower credit score. A credit consumption of 35% and below is usually recommended. High credit card debts affect credit too and your ability to get approved for new loans as well. Some experts believe that debt settlement can hurt your credit score as much as a bankruptcy. Requesting for settlement on your own will not affect your credit score; however, skipping payments will definitely do more harm than good.
Debt settlement typically remains on your credit profile as long as the individual accounts are reported. Generally, the extent to which a collection reduces your credit rating depends on how high the credit score is and when the collection agency reported the debt.
Credit Length (15%)
The extent to which you have had credit also affects your credit score, whether it is just for one month or 25 years. According to credit bureaus, credit length determines up to 15% of your credit score. Credit length refers to the period that any given account has been reported open. An account that has been opened for a long time affects the credit score positively, especially for those accounts that show no record of delinquency.
New Credit Inquiries (10%)
This refers to any review done on your credit profile. An account that shows several credit inquiries within a year will have a negative effect on the credit score directly. When you seek for new credit multiple times within a short period, it indicates that the person is always in debts and relies solely on credit to settle past debts. However, in reality, only hard inquiries affect your credit score negatively. And this occurs whenever a potential lender reviews your credit profile because you applied for credit with them. Hard inquiries can only affect your score for one year.
Mix of Credit Types (10%)
The more different accounts you have in your credit profile, the better situation you have as a mix of credit types could directly influence credit score positively and it is always better than an account dominated with just one type of credit.
A credit score is a significant aspect of an individual’s life because it controls your spending and savings habits. For instance, credit score is very important when buying a home, as every lending institution wants to ensure that the probability of loan repayment is high before disbursing funds to the borrower.