Your credit score affects your financial freedom significantly. It is an extremely important determinant for you to financially support your dreams because lenders’ decisions are often driven based on it.
Whether it is loan approval or better interest rates, a higher credit score brings you closer to financial success as well as excellent long-term savings.
However, a lot of people often wonder what a credit score is and what are the factors that affect it. Read on to know all about credit score and it’s various aspects.
Credit score is a three-digit number used by lenders for evaluating your creditworthiness, that is the likelihood of your timely repaying loans. The FICO score ranges from 300 to 850. The greater the number, the easier it is to qualify for better interest rates and loan approvals.
It is quantified on the basis of credit history, through data on total number of accounts, repayment history, levels of debt, and much more.
A good credit score ranges on the credit scoring model. As a rule of thumb, scores from 580 to 669 are fairly good, 670 to 739 are better still; 740 to 799 is very promising; while 800 and above are basically perfect.
The U.S. market for collection, analysis and disbursement of consumer information about credit is dominated by the three giants of credit bureaus— Equifax, Experian, and TransUnion.
Credit score models are created to determine credit through various factors.
1. FICO Score
The most commonly used credit scoring system in financial institutions is the FICO Score, developed by the Fair Isaac Corp.
Factors such as debt utilization ratio, credit length, repayment history, type of credit, and new openings of accounts are all considered under FICO Score.
Approval on credit cards. mortgages, personal loans, etc. and determination of your payable interest rate is often dictated by your FICO score.
2. Vantage Score
The Vantage Score is developed as an alternative to FICO Score by the credit bureaus Experian, Equifax, and TransUnion and is another rating system for consumer credit.
The difference is that FICO generates a single bureau-specific score for the three credit bureaus individually, compiling information for that particular bureau. In reality, the FICO is not one, but three scores that may bear slight variations due to differences in calculation methods of the bureaus.
The Vantage Score on the other hand, is a single, tri-bureau score that compiles the information of all three bureaus and is used by them all the same as it is.
How Your Credit Score Is Calculated?
The credit reporting giants in the U.S. are responsible for reporting, updating, analysing, and storing the credit histories of various consumers. While their collected information may vary slightly, the credit score is generally calculated by evaluating these five key factors:
1. Payment history (35%)
This category depends on whether your bills are paid punctually. It compiles information on your late payments, and how late they had been.
2. Amounts owed (30%)
This means the ratio or percentage of credit used compared to the amount of credit available to you. It is also called the credit utilization ratio and is recommended to be kept below 30%.
3. Length of credit history (15%)
Owing to greater evaluation data on determining the history of payment, longer credit history is much favourable and less risky in the eyes of bureaus.
4. New credit (10%)
New credit may portray you in a negative light, as too many recent credit applications indicate potential desperation for credit.
5. Types of credit or Credit Mix (10%)
Credit mix or variations in types of credits are indicators that you are capable of managing different types of credit. Whether it’s revolving credit, like credit cards, or instalment credit, like student loans, car loans, mortgage loans, etc.
Credit Score vs Credit Report
A lot of people use these terms interchangeably, but it is important to keep in mind that credit score and credit report are not the same.
Credit score is a single numerical grade for your creditworthiness, while credit report is a compiled analysis, keenly detailing your financial situation.
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Now that you know all about the factors that affect your credit score, it’s important that you also remember that credit is all about responsibility.
Timely payments, mindful budgeting, and proper financial knowledge can easily take you to the road of getting higher credit scores and finding financial freedom.