What Affects Your Credit Score?

By PolicyBazaar
  | Published: 22 February 2021
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A credit score is a powerful number that can impact your major life decisions. It is that number which is used by your lenders in determining your creditworthiness. It helps them ascertain whether there is any risk associated with lending you money. Any lender, be it the credit card company, a bank, a mortgage banker, or an auto dealer, will make sure to check your credit score before they are willing to lend you a loan. The credit scores also help them decide the amount of money they will let you borrow as well as the interest rate they should charge from the amount lent. Other than this, even landlords, employers, and insurance providers often look into credit scores to make out how financially responsible are you before letting you rent their apartment, before offering a job to you, or before issuing you an insurance cover.

Credit card companies look into credit scores before they approve your application for credit cards. Hence, several different companies use these scores to make up their mind about their customers. Utility companies investigate your credit score before signing you up for a new service. 

Does all of this seem overwhelmingly complex? Do you feel like you have to do extensive research in order to figure out what affects your credit score? Fret not! It is not all that complicated and is rather quite simple.

Credit scores are numbers that typically falls somewhere in the range of 300 to 850. There are several factors that could impact this score and lenders are cautious of this number to establish how promising is your ability to repay your debts. As a consequence, these scores play a massive role in whether or not you will get a loan.

Once your financial position changes, it is reflected in your credit scores. Thus it helps to understand what factors affect your scores while at the same time allowing you to improve them over a period of time. Protecting as well as building your credit is extremely important these days and how you deal with the below-mentioned factors will make a significant difference in keeping your credit scores within a desirable limit.

Here are the five biggest factors that have an impact on your credit score:

Bill payment history: When anyone thinks about lending money, they think about whether they will get it back or not. Payment history is among the biggest determinants of your credit score, contributing to 35 percent of your total credit score. It determines whether you can be trusted to pay your funds back or not. It considers the following factors: 

  1. Paying late can have a negative impact on your scores. You should therefore pay all your bills for each account on time.
  2. In case of late payment, how late were you? Was it 30 days, or above 90 days? The more you delay your payments, the worse it will prove for your credit scores.
  3. If your account has been sent to collections, it is a major red flag to any of your potential lenders indicating that you might not repay them back.
  4. How often do you have such negative events as well as the frequency of missed payment you have an effect on your credit score deduction. This means that an individual who has missed a credit card payment five years ago is seen as less of a risk than someone who has missed a major payment recently.
  5. Certain items on your public records can adversely impact your credit report in front of a lender. These items are: 
    • Debt settlements
    • Lawsuits
    • Public judgement against you
    • Liens
    • Charge offs
    • Bankruptcies 
    • Foreclosure
    • Wage garnishments

Credit Utilization: This is the amounts owed by you and it accounts for 30 percent of the credit scores. FICO, a major analytics software company that is known for producing consumer credit scores used by financial institutions before they decide whether to issue credit or not, gives considerable weightage to the credit utilization ratio. This ratio measures the amount of debt you have as compared to the credit limits available to you. The following factors are taken into consideration by this component:

  • How much of the available credit have you used? This does not imply that one has to have zero balance accounts to score high. On the contrary, less is better! Owing a little bit is better than owing absolutely nothing because this shows the lenders that if you borrow some money, you are financially stable as well as financially responsible enough to repay it on time.
  • What is the amount owed by you on specific accounts like credit cards, mortgage, installment accounts and auto loans? Most credit scoring softwares prefer it if you have a mix of credit from different types of accounts but more importantly they see how responsibly do you manage them all.
  • How much is owed by you in total? At the same time, how much is owed by you in comparison to the original sum in the instalment accounts? Here too less is better. For instance if an individual has AED 500 on their credit card that has a limit of AED 5,000, they seem far more responsible than an individual who owes AED 8,000 on a credit card that has a limit of AED 10,000.

Length of the credit history: This contributes 15 percent to your credit scores. The credit scores also take into account the time period for which you have been utilizing credit. The number of years you have had the obligations are important. Apart from this, how old is the oldest account you have and the average age of your accounts is just as important.

Having a long credit history will prove to be advantageous as long as it is not marred by any negative events like later payments. Even a short credit history is not too bad as far as you have been regular in making payments and do not owe too much debt.

This is why experts suggest that you leave your credit cards account open even though you do not use them any more. Losing your accounts will immediately cause your credit scores to decline. The age of your accounts will boost your score immensely.

New credit: This makes up 10 percent of your score. The FICO score tends to take into consideration how many recent accounts do you have. This includes both the new accounts that you have recently applied for as well as the last time that you opened a new account.

Every time that you apply for a line of credit, lenders make sure to investigate or do a hard pull in order to cross check your credit information that was supplied by you during the underwriting process. If you are not approved during a hard pull, it can cause a temporary decline in the credit scores. This happens due to the fact that people tend to open multiple new accounts when they have scarce cash flow or if they are deciding to borrow more.

FICO takes into consideration all the hard inquiries made as well as any new line of credit that has been availed in the past 12 months. It is therefore advisable to minimize your applications for new lines of credit in one year. This does not however include rate shopping as it implies that they simply rate shopping and not actually planning to buy a new car or take a new insurance policy. Therefore, avoid to many searches to keep your credit score unscathed.

Types of credit that are in use: Making up 10 percent of your total score, FICO's calculations while determining the credit scores considers the different types of credit acquired for example, your credit cards, instalment loans, mortgages or store accounts. Having such accounts in the credit report signifies that one has experience in managing different types of credit thus proving to be better for one’s credit score. This is a small part of the credit scores so do not worry too much if you do not have accounts in these categories. One does not have to necessarily open new accounts just to increase the number of credit types.

It will be even better if one has availed for loans for several assets such as a home loan, car loan along with credit cards. These are called installment loans but not having these will not be devastating for credit scores as they form a minuscule part of the total score. 

Different types of account that impact credit scores

  • Revolving Credit: This is generally linked to credit cards but some home equity debts are also included as revolving credit. These credit accounts offer a credit limit while making a minimum monthly payment on the basis of the amount of credit used. These type of accounts tend to fluctuate and do not have a fixed term.
  • Instalment Credit: These type of credits comprise of loans that allow you to borrow a certain sum of money while agreeing to make monthly payments until the loan is completely paid off. These credits include personal loans, student loans and mortgages.
  • Service Account: These include phone bills and utility bills are not included in the credit file by default. The only way for a utility account to impact credit scores is if one did not make payments causing the account to be forwarded to a collection agency.

Things to be vary of

Certain aspects of your credit can positively or negatively affect your credit score. The things one need to be cautious of include-

  • Missed Payments: Even missing your payments by 30 days can heavily impact your score.
  • Too much credit utilization: Availing of too much credit pushes your credit utilization ratio higher and can be a red flag for the creditors.This ratio should ideally lie between the range of 10 percent to 30 percent.
  • Applying too much: This can hurt your credit scores massively because every time a creditor will request for your credit reports, it is recorded as a hard inquiry which will be displayed for years on your credit file. Too many hard inquiries suggest you are  being denied new credit.
  • Account Default: These include bankruptcy, charge-offs, repossession, foreclosure or settled accounts and can hurt your score for a very long time.

Tips to improve credit score

  1. Make sure to pay your bills timely
  2. Reduce your balance on credit cards to bring down the credit utilization ratio
  3. Make sure to make all your outstanding payments
  4. Limit your requests for new credit to bring down the number of hard inquiries made on your credit report
  5. If you have supplied incorrect information on your credit application mistakenly, make sure to correct that error
  6. Monitor your credit reports periodically to change the information on the basis of your current circumstances

 In a Nutshell

The credit scores prove to be vital in getting a loan approved or getting the most favourable interest rates. But one need not obsess over them in order to have an ideal score that will get you brownie points from the lenders. As long as you manage your credit with some discipline, your score will be credit worthy.