Credit Scores

I keep hearing people talk about their credit scores. What are they?

Credit scores are the way that banks keep track of a bunch of the things that they look for when deciding whether or not to give you a loan, such as a mortgage, car loan, or credit card. Outside companies called credit bureaus compile all of the info that shows up on your credit history and banks access that info when you apply for a loan.

How are credit scores calculated?

Credit scores are based on five main factors (ranked in order from largest to smallest impact on your credit score):

• Payment history (35% of your credit score): credit card companies care a lot about how reliably you make your payments because if you don’t pay back your debts to them, they lose money. They like to see that you make every payment on time, and if you miss payments, they take notice of that.

• Amounts owed (30% of your credit score): having too much debt can make it difficult to pay off your loans, so credit card companies look at how much credit card debt you have when they are making the decision to approve or deny you. This also includes comparing your debt to your income, and also how much of your available credit you’re using (credit utilization). Typically, anything over 30% credit utilization is viewed as a negative.

• Length of credit history (15% of your credit score): as we remember from math class, having a larger sample size tends to yield more accurate data about a topic. Credit card companies look at things like how long you’ve had your oldest account, the average age of each of your accounts, and your newest accounts. Longer credit history means more data for them, so that is usually a plus in their eyes when making the decision.

• Types of credit accounts (10% of your credit score): credit card companies also look at the different types of loans that you have, such as car loans, student loans, and mortgages. This can give companies an indication of how well you manage your different accounts and overall credit.

• New credit accounts (10% of your credit score): having too many recently opened accounts and/or hard inquiries (when a company requests to look at your credit information, also known as a hard pull) can be a potential red flag to companies.

Credit scores allow lenders to get a better overall idea of what you’ll be like as a borrower. Certain credit cards have specific credit score requirements, so it’s worth doing your homework on that when you’re researching a credit card. Even if your credit score isn’t what you would like it to be, you can improve it by making consistent payments and lowering your credit utilization and allowing a positive credit history to grow with each passing day. For more information, check out www.experian.com.