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How Is Your Credit Score Calculated?

If you are planning on buying a home, an understanding of your credit score and improving your credit score can make a huge difference in the interest rate you are able to get on your mortgage. This in turn can make a huge difference in your monthly payments. But it can be challenging to improve your credit score if you don’t know how that score is determined.

How Is Your Credit Score Calculated?


Understanding the factors the credit bureau uses to determine your credit score can help you figure out where you can actually improve, and what changes are going to have the most impact.


Your credit score is a critical component of your financial health. It determines your ability to secure loans, the interest rates you will pay, and even your eligibility for certain jobs or rental properties. Understanding how your credit score is calculated, what factors influence it, and how you can improve it is essential for maintaining and enhancing your financial well-being.


So how, exactly, do they calculate your score?


Credit scores are typically calculated using the FICO score model, which ranges from 300 to 850. This model takes into account several factors to determine your creditworthiness. recent article from realtor.com reviewed the main variables credit bureaus use to determine credit score, including:


Payment History (35%)


What it means:  This is the most significant factor in your credit score.  It looks at your track record of paying bills on time.  Late payments, defaults, and collections can severely impact this part of your score.


How it is calculated:  The calculation includes details such as the frequency of late payments, the amount owed, and how recently the late payments occurred.


Amounts Owed (30%)


What it means: This factor considers the total amount of debt you have and how it compares to your total credit limits. This is also known as your credit utilization ratio.


How it is calculated: A higher credit utilization ratio (i.e., using a large percentage of your available credit) can lower your score, while a lower ratio can improve it.


Length of Credit History (15%)


What it means: This measures how long you have been using credit. A longer credit history can positively impact your score because it provides more data on your credit behavior.


How it is calculated: The age of your oldest account, the age of your newest account, and the average age of all your accounts are considered.


Credit Mix (10%)


What it means: This looks at the variety of credit accounts you have, such as credit cards, installment loans, mortgage loans, etc.


How it is calculated: Having a diverse mix of credit types can benefit your score, as it shows you can manage different types of debt.


New Credit (10%)


What it means: This examines how many new credit accounts you have opened recently and the number of hard inquiries made by lenders.


How it is calculated: Opening several new accounts in a short period can be seen as a risk and can negatively impact your score.



Factors That Influence Your Credit Score


Several factors can influence your credit score, either positively or negatively.  Here are some common ones:


Timely Payments:  Consistently making payments on time is crucial.  Late or missed payments can significantly lower your score.


Credit Utilization:  Keeping your credit card balances low relative to your credit limits can help maintain a good score.


Credit History Length:  The longer your credit history, the better.  Avoid closing old accounts, as this can shorten your credit history.


Types of Credit:  Having a mix of credit types (credit cards, mortgages, auto loans) can positively impact your score.


Recent Inquiries:  Applying for several new credit accounts in a short period can lower your score due to multiple hard inquiries.


Tips to Improve Your Credit Score


Improving your credit score takes time and consistent effort.  Here are some actionable steps to help boost your score:


Pay Your Bills on Time

 

Why it matters: As the largest component of your credit score, timely payments are critical.


How to do it: Set up automatic payments or reminders to ensure you never miss a due date.


Reduce Credit Card Balances


Why it matters: Lowering your credit utilization ratio can significantly improve your score.


How to do it: Aim to pay off your credit card balances in full each month. If that is not possible, focus on paying down high-interest cards first.


Keep Old Accounts Open


Why it matters: Closing old accounts can shorten your credit history and negatively affect your score.


How to do it: Even if you are not using an old card, keep the account open and active by making small purchases and paying them off promptly.


Limit New Credit Applications


Why it matters: Multiple hard inquiries within a short period can lower your score.


How to do it: Only apply for new credit when necessary and space out your applications.


Check Your Credit Report Regularly


Why it matters: Errors on your credit report can drag down your score.


How to do it: Obtain a free copy of your credit report annually from the major credit bureaus (Equifax, Experian, TransUnion) and dispute any inaccuracies.


Diversify Your Credit Mix


Why it matters: A mix of different types of credit can enhance your score.


How to do it: Consider taking out a small personal loan or adding a different type of credit, such as an auto loan, to diversify your credit profile.


Bottom Line:


By understanding how your credit score is calculated and taking proactive steps to improve it, you can achieve better financial health and open up more opportunities for your future.  Remember, improving your credit score is a journey that requires patience and persistence, but the rewards are well worth the effort.


If you are interested in learning more or are ready to start your homeownership adventure, contact us. We can help and would be honored to assist you.

 


 

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