How Are Credit Scores Calculated?

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You hear it all the time from every angle: take care of your credit at any age. It is much harder to repair damaged credit than it is to keep your credit score high from the start.

The problem is that this is where the advice usually stops. How are credit scores calculated? What steps can you take to have a better credit score? These answers are essential in having a healthy credit score.

Today, your problem is solved. Find out the answers to these key questions to get on the road to stronger credit.

How Are Credit Scores Calculated?

Each month, financial institutions send a report about you to credit bureaus. Credit bureaus like Experian, Transunion, and Equifax are organizations that keep track of your credit-related history.

Your financial institutions report information like whether your payments are up to date, what your credit balances are, and more.

Based on that information, each credit bureau calculates a score for you that tells creditors whether they want to do business with you.

What Factors Affect Your Credit Score?

When a credit bureau calculates your credit score, they base it on many pieces of information. These are the primary factors they will consider.

1. Payment History

Creditors use your credit score to decide whether they can expect to get their money back from you. It makes sense that they will rely on your past history with making payments.

Missed payments and late payments will lower your credit score in a hurry. On the other hand, if you have multiple credit accounts and you regularly make on-time payments, that will build your credit over time.

2. Credit Usage Ratio

Some types of credit accounts like credit cards are called “revolving credit.” This means you have a credit limit you can use, pay off, and re-use as often as you like. It is different from an auto loan, for example, which you pay off once.

Credit bureaus look at what percentage of your revolving credit is currently used. You can calculate this by adding up the total credit limits for all your credit cards. Then add up the total balance on all your credit cards.

If you have a total of $20,000 among all your credit limits and your total balance is $5,000, your credit usage ratio is 25%. Anything higher than 30% will hurt your credit score.

3. Length of Credit Accounts

One factor that makes you attractive as a borrower is your ability to get on board with a creditor and keep working with them. For that reason, your credit score will be better if you have maintained your accounts for a longer period of time.

Credit bureaus will look at how long each of your credit accounts has been open and calculate the average. To keep your average high, it is best to keep your oldest credit cards open even if you rarely use them.

4. Credit Applications

There is something called a hard inquiry on your credit report. A hard inquiry is any application for new credit, like a loan application or a credit card application.

If you have more than two hard inquiries in a year, it will start lowering your credit score. As this blog explains, this is a factor people need to weigh before debt consolidation.

Learning Your Way to Higher Credit

Everyone wants a better credit score. To reach that goal, though, the first step is learning answers to questions like “how are credit scores calculated,” and “what can I do to improve my credit?” Credit scores make a big difference when it comes to loans and debt.

The facts above are a good start. For more help, though, check out other financial tips on our blog. Visit the Finance section right now!