Your credit score is a number that indicates the level of risk of default you represent to a creditor at a given moment in time. There are several scoring models, but most are based on the FICO Score, a credit score created by the Fair Isaac Corporation, which is used in most lending decisions. It ranges from a low score of 300, which represents extremely high risk, to 850, representing extremely low risk. The credit reporting agencies are not compelled to provide you a credit score at no cost. However, they are available for purchase through the credit reporting agencies. The FICO Score consists of five components.
How you’ve paid—The most significant factor in the score, 35% of it, is how you’ve paid your creditors. Consistent, on-time payments will improve your score. Late or missed payments will have a negative effect on your score. The more frequent, recent, or severe the missed payments are, the greater the impact they will have.
What you owe—Thirty percent of your score is based on how much you owe, particularly in relation to your available balances. Maxing out your accounts can have a detrimental effect on your score. Keeping your balances at half your limits or below can help keep your score strong.
How long it’s been—The age of your accounts makes up 15% of your score. Typically, the longer your credit history, the better. Having a longer credit history gives more data to base lending decisions on.
What kind of credit—Having a variety of credit types is generally positive for your credit score and shows that you can handle a mix of credit. This is 10% of your overall score.
What’s new—Having many new accounts or excessive inquiries indicating that you’re applying for new accounts can indicate greater risk, as it looks like you are in need of a lot of credit quickly, which could be indicative of a financial problem. New credit makes up 10% of your credit score.
A significant factor that is not included in your credit score is your income. When most lenders make decisions about granting credit, the credit score is only part of the decision-making process. They may also consider income, debt-to-income ratio, and other factors.
Lenders who use credit scores in determining whether to grant credit may also use them to determine the price of the credit, a process called risk-based pricing. For example, two people may apply for the same loan with the same financial institution. One who has a credit score of 740 may get the loan with an interest rate of 4.2% while the other with a score of 680 may get it with a rate of 6.5%. A third person with a score of 580 may be declined outright.
There are steps you can take to improve your credit score. Making payments consistently and on time is the best practice for a high score. Also, avoid maxing out your accounts and submitting excessive credit applications in a short period of time.