A good credit score is important for financial success, and plays a key role in how lenders determine your creditworthiness to be approved for a mortgage, loan or credit card. Not only can this score affect whether or not you are approved for these applications, but it also affects the interest rate you are charged if you are approved. Yet how this little 3-digit number is calculated is a mystery to many, but it doesn't have to be.
There are some basic guidelines when it comes to determining your credit score. By knowing what these factors are, you'll be in a better position to work towards strengthening your credit score.
Here are the 5 components - and their respective weights - that go into calculating your credit score.
1. Payment History - 35%
Your payment history has the biggest weight - 35% - when determining your credit score. This component shows your payment habits, such as whether or not your payments are made on time, how often payments are missed, whether your payments are made in full or not, how many days past your bills were paid, and the most recent missed payment activity. The higher to proportion of missed payments, the more points you risk losing. On the other hand, the higher the proportion of on-time payments, the higher your score will be.
2. Current Loan and Credit Card Debt - 30%
Thirty percent of your credit score goes towards how much you owe on outstanding loans and credit card debt. This part of the score is based on the total amount that you currently owe, how many accounts you have, the type of accounts you have, and the ratio of money owed versus the amount of credit available.
Your credit score will be negatively affected if you have high balances and credit cards that have been maxed out. On the other hand, you credit score can be boosted with smaller balances and on-time payments. Loans that are closer to being fully paid off can improve your score because it displays a success payment history.
3. Length of Credit History - 15%
How long your credit history is makes up 15% of your score. Your score will be higher the longer your history of making on-time payments is. Having debt in the past is actually a good thing - if you managed it properly. It gives lenders something to look at and evaluate before approving you for a loan.
4. Types of Credit Being Used - 10%
Having a healthy mix of different accounts can help improve your credit score. These can include home loans, credit cards, and installment loans (such as a mortgage). Your history of making timely payments on loans such as these will positively affect your score. This portion makes up 10% of your overall calculation.
5. New Credit - 10%
The final 10% of the calculation is based on any recent credit activity. If you've been opening a number of different accounts lately, it may point to underlying financial distress, which can lower your credit score. On the other hand, if you've had the same credit cards or loans for many years, with a history of making timely payments on them, your score can be improved.
The best way to improve your credit score is to be responsible with your loans and credit cards, and make timely payments. To help you get a handle on your loans and finances, consider using an online tool, like Mint's Credit Monitor.
This handy tool can give you a complete picture of your credit history, as well as help you monitor daily activity on your credit reports, notify you of changes, and alert you of potential fraud. Visit iOfficeCorp.com to learn more about how Mint's online financial tools can help you attain - and maintain - a good credit score.
Lisa Simonelli Rennie is a freelance web content creator who enjoys writing on all sorts of topics, including personal finance, investing in stocks, mortgages, real estate investments, and anything else to do with the world of economics.