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Six Ways Your Credit Score is Calculated

 A Look at the Factors that Influence Your Credit Score

When talking about credit scores, some find the topic to be confusing, daunting, and downright intimidating. But is this really uncharted territory? It doesn’t have to be.

A credit score is a number assigned to a person based on their financial history and how they handle credit. This score uses several factors to determine a borrower’s creditworthiness or their level of financial responsibility.

Lenders, such as credit card companies, mortgage lenders, and auto dealers, use this score to determine the level of risk for lending money to a borrower. A credit score will also influence interest rates and how much they are willing to lend.

Employers, landlords, and insurance companies may also check a person’s credit score to see if they are financially responsible.

Having a good credit score is important for many things in life, from getting a job to buying a home. And if your credit is suffering, it’s important to understand what affects your credit score so you can build and manage your credit.

To help you better understand how your credit score is calculated, here’s a look at the six major factors that contribute to your credit rating.

Six Factors That Contribute to Your Overall Credit Score (And Their Percentages)

Your credit score is based on a record of your financial behaviour and is influenced by the following factors:

Payment History (35% of Credit Score)

The most important factor for your credit score is your payment history. In the eyes of lenders, past payment behaviour will forecast future payment behaviour. So if you pay your bills on time every month, and you have been doing this for years, then your credit should be in good shape.

But if you are late making payments, you will be considered a risk to lenders since you may not pay future payments on time (or at all). As a result, your credit score will drop.

The payment history portion of your credit score considers the following:

  • Whether you have paid your bills on time for each credit account—any late payment hurts your credit score.
  • The frequency of missed payments.
  • If you paid any bills late, how late were you—i.e. 30 days, 60 days, or 90+ days? The longer payments are left overdue, the worse this is for your credit.
  • Whether any of your bills were sent to collections—which is a major red flag to lenders.
  • If you have marks on your credit history. These marks include charge offs, debt settlements, lawsuits, bankruptcies, foreclosures, wage garnishments or attachments, liens, and public judgements.
  • The time that has passed since the last negative event. For example, if you missed several payments five years ago, you are considered less of a risk than if you missed a big payment this year.

The easiest way to improve your payment history (and credit score) is by making consistent on-time payments. For help with this, consider setting up automatic payments, so you’re never late making a payment again. And if you’re late, don’t be more than 30 days late.

Utilization (30% of Credit Score)

Utilization is the second largest factor that affects your credit score. Utilization compares the amount you owe to the amount of available credit you have.

The utilization portion of your credit score considers:

  • The amount of credit you have
  • The amount of credit you have available to you
  • The number of accounts that have balances
  • The number of accounts that are over the limit

From a lender’s perspective, borrowers who habitually max out their credit cards or get very close to their credit limits are unable to handle debt responsibly. So, to help your credit, try to pay down high balances that are close to the credit limit.

However, also keep in mind that credit score is calculated using a complex algorithm, and there are many varying opinions regarding the best utilization to have. This means every person will be impacted differently depending on the balance they do carry.

So, while we encourage borrowers to have reasonable limits on credit items like credit cards and lines of credit, it is also important to note that holding a $2,000 balance on $5,000 limit can actually have a positive affect on your credit score compared to having a $2,000 balance with a $2,000 limit. For this reason, it may be worth asking your financial institution to increase your credit limit (but not using any of this newly available credit). Doing so will improve your credit utilization along with your overall credit score.

Length of Credit History (15% of Credit Score)

The length of your credit history is how long you’ve had active credit accounts open along with the length of time since the account’s most recent action. The longer you’ve had a credit history, the better, since it provides more information and a more accurate picture of your financial behaviour.

So, open credit, use credit, develop a good credit history, and don’t close credit accounts if you don’t have to. It is recommended that you leave credit card accounts open even if you don’t use them anymore.

Having Multiple Types of Credit (10% of Credit Score)

Having different types of credit with a good history is beneficial for your credit score, i.e. having a mix of installment loans and revolving credit. This mix includes credit cards, lines of credit, and loans, such as a car loan, mortgage, or student loan.

Having multiple types of credit will help your credit score because it shows that you can manage and pay off different types of credit.

Inquiries (5% of Credit Score)

Inquiries refer to credit checks and make up a small portion of your credit score. Soft inquiries won’t affect your credit and include inquiries made when you check your own credit.

Hard inquiries, also called hard pulls, will cause a small, temporary decline in your credit score. Lenders make hard inquiries to check your credit information during the underwriting procedure when you apply for new credit.

Hard inquiries affect your credit score since the score assumes you are a greater risk. If you opened new accounts recently, you might be perceived as having cash flow problems or planning to take on a lot of new debt.

Since a history of recent hard inquiries and new lines of credit in the past 12 months will affect your credit, limit the number of times you apply for and open new credit in a year.

But if you’re rate shopping and have multiple inquiries from auto or mortgage lenders, these should only be considered as one inquiry, especially if made within 45 days.

Calculation of All of the Above (5% of Credit Score)

Lastly, 5% of your credit score is based on a calculation of all of the above factors. The pros and cons of each factor are also weighed.

The Takeaway

If you want to improve your credit score, keep these factors in mind to help you start building and maintaining your credit.

And if you’re uncomfortable with your credit score or just the topic of credit, remember that everyone who has ever borrowed money from a lender has a credit score. Some scores are good, some are bad, and all scores all calculated the same way and can be improved upon with some work and time.

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