Have you ever wondered what a credit score is, how it is calculated, and how it will affect your personal finances? Credit scores affect a far greater number of aspects of your life than just whether or not you can secure credit. Insurance rates, certain job opportunities, and your ability to buy a home can all be influenced by your credit score. Because credit is such an important aspect of living a successful and secure life, here’s a basic overview of how a credit score is calculated.
What is a credit score?
According to CrediReady, “a credit score is simply a 3 digit number that the 3 major credit bureaus will give you, This number is essentially a brief summary of your credit standing. The numbers will range from 300 (bad credit) all the way to 850 (perfect credit).”
A credit score is an overall determination of how much risk a lender or creditor is taking on by extending credit to you. The higher your score, the lower the risk you have shown yourself to be to lenders. When you have a low score, however, it means that lenders are taking a pretty sizable risk by lending to you. This means you will generally pay higher interest rates and be given less favorable loan terms. For example, if you wanted to apply for auto financing, the lender will offer financing programs based on your credit. You may qualify for a loan with a less-than-ideal credit score, but you would have better terms if your credit score was higher.
Here are some of the factors that affect your score:
If you have been sued or someone has taken you to court, then these records can affect your credit score. Other public records that can affect your credit score are a divorce, a bankruptcy, or an eviction.
Late or Missed Payments
Lenders are looking for responsible borrowers that pay their bills on time. When you are late paying your bills or miss payments entirely, you are not proving yourself to be a good credit risk.
If you go long enough without making a payment, your creditor will eventually report your loan as being defaulted on. A defaulted loan will generally affect your credit score significantly more than a late or missed payment.
Debt to Credit Ratio
Another thing that creditors are looking for is people who do not live at the very edges of their means. When all of your credit cards are maxed out, you are considered high risk. Many creditors want to see a balance of no more than 30% of your total available credit being used.
Length of credit
The longer your credit history, the more information lenders have to determine your creditworthiness. Borrowers who have made many years of on-time payments will generally have a much higher credit score than those who have only recently begun to establish their credit.
Types of credit
Lenders often want to see a good mix of credit, such as auto loans, home loans, store cards, and major credit cards. If you only have store or gas cards, for instance, your credit score will generally be lower than those that have a variety of credit.
Understanding your credit score and how it is determined is an important part of fiscal responsibility. Your credit score will affect many areas of your life, so it’s important to not only understand it but manage it well.
While we don’t yet have a credit calculator on our site, CalcuNation is happy to share a number of other useful calculators with you! Check out other calculators that might help you with personal finances, such as our business calculators!