If you have been using credit to finance your individual or business projects, you have credit reports, which are your payment history without any judgment. However, your credit score is a judgmental approach because it is a cumulative figure that measures how others perceive you in relation to handling debts. It ranks you on how trustworthy you are with regards to paying debts. Lenders will decide whether to give you a loan or not depending on your credit score and will assign you an interest rate depending on the range within which your score falls. Surprisingly, credit scores are not only used by lenders but also by landlords, leasing companies, insurance firms, employers, and other parties as a measure of how responsible you are.
Most common credit scores
The most commonly used credit score is the FICO score, a tool that was created by FICO (previously called Fair Isaac Corporation). Although it is not the only type of credit score, it is the one that is mostly used by lenders to gauge the risk involved while offering a credit product to a borrower. The FICO score ranges between 300 and 850, and the higher the number, the more impressive the score. Generally, any score above 740 is deemed as excellent and will enable you to get a good interest rate, but scores below 650 attract high interest rates while taking loans or credit cards if you manage to qualify for any.
Computation of FICO score
The proprietary formula that FICO uses to calculate credit score is still a secret that they still keep to themselves. However, it is well known that the credit score calculation depends on five primary things with different levels of importance. Below are the factors used to compute credit score and their relative contribution:
Payment history -35%
This is the most crucial factor in computing the credit score and considers if you pay your debtor bills on time.
Amount owed – 30%
This considers your credit utilization ratio, or the amount that you have used of the total credit available. Lenders view those who are almost maxing their credit as possible defaulters or late payers.
Length of credit history – 15%
This is calculated by finding the average age of your accounts and at the same time considers the duration that has elapsed since the last time those accounts were used. Those whose accounts are fairly new and have a poor score could consider increasing the length of their credit history by being added as authorized users in aged, well-performing accounts or tradelines. They can seek tradelines for sale from reputable companies to boost their credit score and enjoy the benefits of having an impressive score.
New credit – 10%
Many new credit applications are an indicator of a person facing a lot of financial pressure. As such, making several new credit applications within a short time are likely to cause in a drop in your score.
Type of credit used – 10%
FICO score computation also considers if you have a blend of several types of credit, for instance auto loans, mortgages, student loans, and others. The lenders just want to figure out if you can handle different accounts with great responsibility.
Conclusion
Your credit score is a product of only the information that is in your credit report and is not influenced by any extra information that a lender may include in their appraisal of your application, for example your income at that time, the duration over which you have been employed, and other factors. The most important thing is to know that your score is used by lenders and other entities, so you need to maintain a good credit score and keep improving it over time.
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