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Credit Scores – What are they?
Credit scores are numerical representations that help lenders assess an individual’s creditworthiness. They provide a quick snapshot of a person’s credit history and ability to repay debts. A good credit score means a less-risk borrower, and a bad credit score means a high-risk borrower. Financial institutions and other creditors typically use these scores to determine the risk associated with lending money to an individual.
What are the five Credit Score factors?
In the United States, the most common credit scoring model used is the FICO Score. It considers several factors when calculating an individual’s credit score. There are mainly five factors that influence credit scores, they are:
• Payment History: This factor is important in determining your credit score. It reflects whether you have made on-time payments.
• Credit Utilization: This factor looks at the amount of credit you are currently using compared to your total credit limit. Maintaining a low credit utilization ratio (using less than 30% of your available credit) can positively impact your score.
• Length of Credit History: The length of time you have held credit accounts plays a role in your credit score. A more extended credit history can be advantageous, allowing creditors to see your long-term credit behavior.
• Credit Mix: Lenders like to see a diverse mix of credit types, such as credit cards, installment loans, and retail accounts. A well-rounded credit mix can deliver a positive impact on your score.
• New Credit Applications: With each credit applied comes a hard inquiry; this generates on your credit report significantly. Multiple hard inquiries in a short period can slightly lower your credit score as it may indicate higher credit risk.
What can impact Credit Scores?
- Payment History: Consistently making on-time payments helps maintain a good credit score, while late or missed payments can lower it.
- Credit Card Balances: High credit card balances relative to your credit limits can negatively affect your credit score, whereas keeping balances low can be beneficial.
- Credit Applications: Applying for numerous credit accounts within a short period can lead to multiple hard inquiries, potentially lowering your credit score.
- Public Records: Bankruptcies, tax liens, and other negative public records can significantly lower your credit score.
- Debt Collection: Accounts that are sent to collections can have a severe negative impact on your credit score.
- Credit Account Age: Closing old credit accounts can shorten your credit history and potentially lower your score.
- Credit Mix: A mix of different types of credit (e.g., credit cards, mortgages, installment loans) can positively impact your credit score.
- Credit Monitoring: Regularly checking your credit report and addressing any errors or discrepancies can help maintain a healthy credit score.
My Credit Score needs to be improved. What can I do?
It takes a reasonable amount of time to improve your credit score. Consistent efforts are needed to see an improvement. Here are some steps you can take to work towards a better credit score:
- Check Your Credit Report: Obtain a free copy of your credit report from each major credit bureau (Equifax, Experian, and TransUnion) once a year. Review it for errors or inaccuracies and dispute any incorrect information.
- Pay Bills on Time: One of the most critical factors in your credit score is your payment history. Make sure to pay all your bills, including credit card bills, loans, and utilities, on time to establish a positive payment history.
- Reduce Credit Card Balances: Aim to keep your credit card balances well below their credit limits, ideally under 30%. High credit utilization can negatively impact your score, so focus on paying down credit card debt.
- Avoid Opening Unnecessary Credit Accounts: Opening multiple new credit accounts in a short period can lower your credit score due to increased inquiries and reduced average account age.
- Build a Diverse Credit Mix: Having a mix of different types of credit accounts, such as credit cards, installment loans, and retail accounts, can positively impact your credit score. However, only open new credit if you need it.
- Pay off Debts: Reducing your overall debt will improve your credit score. Prioritize paying off high-interest debts first and consider debt consolidation if it helps you manage your payments better.
- Keep Old Accounts Open: Closing old and positive credit accounts can shorten your credit history, potentially lowering your credit score. Keep older accounts open and active, even if you don’t use them frequently.
- Limit Credit Inquiries: Each hard inquiry generated when applying for new credit can slightly lower your score. Apply only when necessary.
- Schedule Payment Reminders On Phone: Missing payments and paying late can harm your credit score. Consider setting up payment reminders or automatic payments to ensure you never miss a due date.
- Work with Creditors: If you’re struggling to make payments, contact your creditors or lenders to explore options such as payment plans or hardship programs. This proactive approach can prevent your accounts from going into collections.
It is essential to understand that improving your credit score is a continuous process, and there are no shortcuts. Focus on responsible credit behavior, avoid unnecessary debt, and be patient, as positive changes in your credit score will take time to reflect on your credit report.