Understanding What Impacts Your Credit Score

For many people, credit scores can be confusing. They have a major impact on your life but it’s difficult to work out exactly that impacts your score. To better understand your credit score, it’s important to know why it exists and why it’s so important. Here, we’ll go through those reasons to give you more clarity about how the system works. After that. we’ll look at what affects the score and how to go about making yours better. Let’s get started.

Why Do Credit Scores Exist?

Credit scores are effectively a risk assessment. The scores typically range from 300 to 850 and the higher your score, the less risky you appear to lenders. Knowing this can give you an insight into what they are looking for. For example, a teenager most likely won’t have a good credit score as there will be very little credit existing on their profile. Lenders would be hesitant to give away large sums as they don’t have any proof the applicant knows how to manage money. Therefore, never having credit isn’t seen as a good thing. Those using credit checks want to see that you have used various forms of credit and have a history of easily managing it. If so, they are usually happy to lend higher amounts at more affordable rates. It isn’t a perfect system. As a recent change in circumstances or not needing past credit can work against you. Due to this, it’s good to know exactly what effects your score and what you can do to change it.

Payment History

By far the biggest factor on your credit score is your payment history. Late payments and defaults will stay on your credit report for seven years. This is why if you feel as though you will miss a payment, it’s important to talk through it with your creditors. If you have recently missed payments, then all is not lost. As time passes, the impact of a missed payment will fade before it eventually disappears. For example, a default that you missed five months ago will have a bigger impact than one you missed five years ago. The bottom line is that if a lender sees that you’ve missed payments with others, they fear that you’ll miss payments with them. Once you start to become consistent with making payments, your score will start to recover.

Credit Utilization Ratio

Your credit utilization is another important measure used by credit reference agencies. This looks at the amount of credit you’re currently using and compares it against the amount of credit you could use. For example, if you have a credit card balance of $500 but your credit limit is $5,000, that would be a great credit utilization ratio. It shows that you’re easily handling your credit and could afford to take out more. If your balances are close to your credit limit, then it reflects badly on your credit score. It will seem as though you’ve reached the limit of your expenditure and may struggle to make payments if you take out further credit. Ideally, you want to keep your credit utilization at around 10% of your limit but up to 30% is still good. Any higher than that, your credit rating may start dropping a little, even if you are regularly making payments. Along with credit utilization, the overall amount you have borrowed is also taken into account. If you’re looking to increase your credit score, then reducing balances is going to be one of the most effective ways to do it.

Length of Credit History

The longer you’ve been good with credit, the more trusted you’ll be. For example, all other things being equal, someone who has only used credit for two years will have a worse credit score than someone who has five years of history. This can be frustrating to those looking to improve their scores right away. However, as time passes you can be content that your score will be improving. Also, this doesn’t affect your credit history as much as payment history. If you’re worried about closing down accounts and their history disappearing from your record, don’t be. A closed account that didn’t have any missed payments can stay on your credit report for up to 10 years.

Credit Mix

Lenders want to see that you have experience in handling different types of credit. They’ll want to see a mix of installment debt such as various types of loans, and revolving accounts, such as credit cards. There are also ways to get your bills added to your credit report, but not every agency will take this into account. You shouldn’t take on significant debt to simply boost your credit mix but when managed effectively, it can help to boost it.

New Credit Inquiries

Credit scores can be complicated as new inquiries can have a negative effect on your score. This is because you’ll be taking on more debt and lenders will be worried about whether you can afford any more. These come from hard inquiries that are generally needed for loan and credit card applications. Due to this, you should be mindful about when you make inquiries. For example, if you’re hoping to apply for a mortgage in the next month, it won’t be a good idea to apply for a credit card today. Thankfully, the impact on your credit score is only small and temporary. It will generally recover within a few months. Due to these factors, it’s important to thoroughly research any credit you apply for and be confident of acceptance.

Think About Your Financial Decisions

Improving your credit score can be tricky. For example, increasing your credit mix can negatively affect your score in the short term. This is because applying for new credit which can temporarily reduce your score, but you’ll end up with longer term benefits. Due to this, it’s important to think about each financial decision you make and the consequences they have. The bottom line with your credit report is that as long as you’re maintaining payments and keeping your balances low, you’re likely to have a good score.