How is Your Credit Score Calculated? 5 Key Factors

Ever wondered how your credit score is calculated? What are the Credit Score ranges?

Your credit score holds considerable power when it comes to your financial life.

It can open doors to low-interest loans, better credit card offers, and even influence your ability to rent a home or land a job.

In this article, we’ll clarify the credit scoring process and explore the five key factors that affect your credit score. By the end, you’ll be equipped with the knowledge of how your credit score is calculated and various ways to improve your financial standing.

What is a Credit Score?

A credit score is a 3-digit number that reflects your creditworthiness. It is a measure of how likely you are to repay a loan on time.

Generally, lenders, landlords, and even potential employers use this number to evaluate your financial responsibility. The higher your score, the more trustworthy you appear to these entities.

Why is Your Credit Score Important?

Your credit score is important because it affects your financial opportunities. It can affect your ability to get approved for loans and credit cards, and the interest rates you pay.

A good credit score can lead to a lower interest rate on loans, saving you money in the long run, and can also help you qualify for better loan terms and conditions.

It can also make it easier to rent a home, get a credit card, or even secure a job. On the flip side, a low credit score can result in higher interest rates and limited financial options.

How is Your Credit Score Calculated?

Your credit score is calculated using a complex formula that takes into account five factors. These five key factors play a significant role in determining your credit score. Let’s break them down.

1. Payment History (35%)
2. Amount Owed (30%)
3. Length of Credit History (15%)
4. New Credit (10%)
5. Credit Mix (10%)

Factor 1: Payment History (35%)        

Your payment history is the most important factor in your credit score. It is a record of your past payments on credit accounts and shows lenders how consistently you have made your payments in the past.

It shows whether you’ve paid your bills on time or if you have any late or missed payments. A missed payment can have a significant negative impact on your credit score, so it is important to make all of your payments on time and in full.

Late payments, collections, and bankruptcies can have a significant negative impact on your score.

How to Improve Your Payment History?

• Always pay your bills on time or early (if possible).
• Set up automatic payments for all of your bills.
• If you are having trouble making a payment, contact your creditor immediately to see if they can work with you to make a payment plan.
• If you have late payments on your record, negotiate with creditors to remove them in exchange for paying off the debt.

Factor 2: Amount Owed (30%)

The factor Amount Owed is the amount of debt you owe on your credit accounts, relative to your credit limits. It is also referred to as your Credit Utilization rate.

Lenders want to see that you are not overextended and that you have the ability to repay your debts. It is important to keep your credit utilization ratio low, which is the amount of credit you use divided by the total amount of credit you have available.

How to Improve Your Amount Owed?

• Pay down your credit card balances.
• Pay down high-interest debts first.
• Avoid maxing out your credit cards.
• Transfer high-interest debt to a lower-interest credit card.
• Avoid opening new credit accounts if you have high balances.

Related: How to Use a Credit Card to Build Credit Score

Factor 3: Length of Credit History (15%)

The length of your credit history is a measure of how long you’ve had credit accounts and the average age of your accounts. It provides insight into your experience managing credit over time.

Lenders generally prefer to lend to borrowers with a longer credit history, as this shows that you have a proven track record of repaying your debts.

How to Improve Your Length of Credit History?

• Keep your oldest credit accounts open to maintain a lengthy credit history.
• Open new credit accounts responsibly.

Factor 4: New Credit (10%)

New credit examines the number of recently opened accounts and credit inquiries. Opening many new accounts in a short period can be seen as a red flag.

When you open a new credit account, it triggers a hard inquiry on your credit report. Hard inquiries can temporarily lower your credit score by a few points.

Frequent credit applications can indicate financial instability, potentially lowering your credit score.

It is important to limit the number of hard inquiries on your credit report, especially if you are planning to apply for a major loan shortly.

How to Manage New Credit?

• Only apply for new credit when necessary.
• Research and Compare Credit offers before applying
• Shop around for the best interest rates and terms before opening a new credit account.

Factor 5: Credit Mix (10%)

Credit mix indicates the types of credit accounts you have. Having a variety of different types of credit such as credit cards, installment loans, and mortgages, can help to improve your credit score.

This shows lenders that you can handle different types of credit responsibly. A diverse mix can positively influence your credit score.

It suggests your ability to manage various types of credit. Maintaining a good mix naturally over time can enhance your credit score.

How to Improve Your Credit Mix?

• Apply for different types of credit, such as credit cards, installment loans, and mortgages.
• Don’t open new accounts just for the sake of diversifying your credit mix, consider it when you genuinely need a different type of credit.
• Manage all of your credit accounts responsibly.

These are the five factors affecting credit score.

Credit Score Ranges

Credit scores are typically divided into five ranges:

• Very Poor: 300-579
• Fair: 580-669
• Good: 670-739
• Very good: 740-799
• Excellent: 800-850

How to Improve Your Credit Score?

There are several things you can do to improve your credit score, including:

• Make all of your payments on time and in full.
• Keep your credit utilization ratio low.
• Keep your oldest credit accounts open.
• Open new credit accounts responsibly.
• Have a variety of different types of credit.
• Dispute any errors on your credit report.

By following these tips, you can improve your credit score and save yourself money on interest.

Conclusion – Credit Score Calculation

Your credit score is an important number that can affect your ability to get approved for loans and credit cards, and the interest rates you pay. Understanding how your credit score is calculated is the first step towards improving it.

By understanding how your credit score is calculated and taking steps to improve your credit score, you can save yourself money and improve your financial future.

FAQs – How is Credit Score Calculated?