What goes into my credit score?
Have you ever wondered how your credit score is calculated, how something as complex as an individual's credit history is represented by a simple three-digit number?
It's a great question and something worth further explanation.
The credit scoring system became prevalent during the 1980's as a way for lenders to quickly evaluate a potential borrower's creditworthiness. Now credit scoring is used by lenders, landlords, and utility companies to evaluate your credit behavior.
Here's an easy way to think about credit scores: they're like pies. Similar to a recipe for a pie, the recipe for a credit score calls for the blending together of numerous ingredients to form a resulting product. Tastier pies have better ingredients. So do more palatable scores.
So what are those ingredients, anyway?
Using VantageScore® 3.0 as an example, let's look at 5 of the main ingredients that factor into your credit score:
Payment History. Let's face it, if someone has a consistent history of making payments on time, they should probably be perceived as less of a risk than someone with the same exact credit profile who only has an intermittent history of on-time payments.
Outstanding Debt. This is the amount owed. Reducing Outstanding Debt is always in the best interest of your credit health.
Utilization. Utilization measures the amount of available credit one is using. VantageScore® Credit Score recommends keeping balances below 30% of credit limit.
Credit Type & History. History again? Yep, all else equal, someone with a longer and diversified credit history is typically seen as a less risky borrower. This fact reinforces the importance of establishing a solid foundation of good credit as early as possible.
Recent Inquiries. Each time someone authorizes a lender or business to make an official inquiry of his/her credit in connection with seeking credit, the score typically drop a little bit. It is important to apply for credit in moderation.
What does this all mean?
Good credit scores and delicious apple pies have this in common: quality ingredients. So whether you're borrowing or baking, what matters is what you put into it.
When you are preparing for a major purchase make sure you check your credit scores and credit reports from all three credit reporting agencies: TransUnion, Equifax and Experian. Looking at your scores and reports a few months before your loan application will help you get a complete picture of your credit health.
This information is for educational purposes only and does not constitute legal or financial advice. You should always seek the advice of a legal or financial professional before making any legal or financial decisions.
Source: What Influences Your Score (VantageScore Solutions, LLC);