Your credit score plays a major role in many financial decisions you make throughout your life, especially when it comes to purchasing a home. It determines whether you are eligible for loans and the interest rates you will receive. Therefore, understanding how your credit score is determined and how you can raise it can drastically impact your financial wellbeing.
Credit scores are typically determined by the three major credit bureaus – Experian, Equifax, and TransUnion – using a formula called the FICO score. This formula considers five key factors, which are explained in more detail below.
- Payment history
Payment history is the most significant factor affecting your credit score, accounting for approximately 35% of the total. This factor takes into account whether or not you have made payments on time and if you have any missed payments or a history of defaults. - Amount of debt owed
The amount of debt you owe to different lenders accounts for approximately 30% of your credit score. This includes outstanding balances on credit cards, loans, and mortgages. It also looks at the ratio of your outstanding debt to your available credit. - Length of credit history
Your credit history’s length contributes to approximately 15% of your overall score. This factor considers how long you have had your credit accounts open – the longer, the better. - Types of credit
Your credit score considers the types of credit you have used, accounting for approximately 10% of your overall score. This includes credit cards, loans, and mortgages. - New credit
Finally, new credit accounts for approximately 10% of your total score. It considers how many new credit accounts you have opened recently and how many credit inquiries you’ve made in a short amount of time.
Now that you understand how your credit score is determined, it’s time to discuss some ways to raise your score. - Pay bills on time
As mentioned earlier, payment history has the greatest impact on your credit score. Therefore, paying your bills on time should be a top priority. If you struggle with remembering your due dates, consider setting up automatic payments or reminders on your phone. - Keep credit card balances low
Your debt-to-credit ratio is essential, so it’s crucial to keep your credit card balances low. If you can, try to pay off your credit card balance in full each month. - Check your credit report regularly
Mistakes on your credit report can negatively affect your score, so be sure to check it regularly for errors. If you do spot an error, dispute it as soon as possible. - Apply for new credit accounts sparingly
Applying for new credit accounts frequently can negatively impact your score. Instead, try to avoid opening new accounts and focus on paying off your current balances. - Keep old accounts open
As mentioned earlier, the length of your credit history accounts for approximately 15% of your score. Therefore, it’s best to keep your old accounts open even if you don’t use them anymore. - Pay off outstanding debt
It’s essential to pay off your outstanding debts to improve your credit score. Start with the accounts with the highest interest rates and work your way down. - Aim for a higher credit limit
If possible, try to increase your credit limit. This can help improve your debt-to-credit ratio, which is a crucial factor in determining your credit score.
In conclusion, your credit score plays a significant role in many financial decisions throughout your life. Keeping track of your credit report and taking steps to raise your score can make a tremendous difference in your financial wellbeing. By paying bills on time, keeping credit card balances low, checking your credit report regularly, applying for new credit accounts sparingly, keeping old accounts open, paying off outstanding debt, and aiming for a higher credit limit, you can begin to improve your credit score over time.
