Understanding Your Credit Score
Credit scores range from 300 to 850, and they are determined by a system established by the Fair Isaacs Cooperation (FICO). This number may be used to inform lenders of your creditworthiness, or the risk you present as a borrower. Put simply, credit ratings tell banks and other institutions whether they should lend you money and the rates they should charge. The score is largely determined by five factors: payment history, amounts owed, length of history, types of credit, and account inquiries.
Payment History (35%)
This is the largest factor, and its determined by whether you pay your bills on time. Late payments, defaulted loans, and bankruptcy are red flags to lenders, all reasons payment history accounts for up to 35% of your score. The best way to improve your score is to pay bills on time and to check your score regularly to make sure there are no errors.
Amounts Owed (30%)
This refers to both the amounts of individual accounts and the total debt you owe in general. It's largely based on the portion of the credit line you are using, so it's often relative to your current financial situation. Ideally, you shouldn't spend more than one-fourth of your income on bills. If you have too much debt already, lenders will be wary of giving you more money.
Length of Credit History (15%)
The length of credit history is important for two reasons. First, it helps lenders get a more accurate picture of you as a creditor; the more information there is about you, the more assumptions a creditor can safely make. Second, a long history shows lenders that you can be responsible. If you've steadily paid off a mortgage for 30 years, your credit score will skyrocket.
Types of Credit Used (10%)
Not all credit is created equal. Revolving credit accounts, like those used for credit cards, aren't as impressive as a mortgage or car loan. Banks want to see intelligent borrowing, not impulsive buying habits.
Account Inquiries (10%)
Finally, the number of recent account inquiries can also send bad signals to lenders. If you're trying to borrow money from several different places at once, it may look like you're in financial trouble. That's why you should always think carefully before letting someone make an inquiry into your account.
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