Lenders use credit scores to determine the risk of borrowers before giving them loans. These lenders include auto dealers, credit card companies, and mortgage bankers. A credit score is used by them to decide the amount to be given. It also helps them to decide the interest rate to be applied to it.
Landlords and insurance companies might also check your credit score. Your credit score shows how responsible you are financial. This information is then used for renting out an apartment or issuing an insurance policy. There are some key factors that affect your credit score. Let’s see what are they:
1. Payment history
There’s one question that lenders always consider before giving their money to someone else. The question is whether the borrower would repay the loan amount fully. Your payment history reflects everything related to your payments. It takes into account whether you’ve paid your bills on time for each account.
Sometimes, there can be delayed payments due to certain situations. In this case, how late you’ve been with the payments is also considered. If any of your accounts have been sent to collections, it would also reflect in the payment history. It also takes into consideration foreclosures, bankruptcies, and lawsuits.
2. Length of credit history
Your credit score is also determined by how long you’ve been using your credit. Long credit history is always helpful if it doesn’t show any negatives, such as late payments. If you have a short credit history, that’s fine. The only condition is that you should be making your payments on time and your debt must be manageable.
Experts of personal finance, therefore, recommend leaving credit card accounts open even if they’re not used. The account of that credit card would help boost your score.
3. Credit utilization ratio
You might be making your payments on time, but this doesn’t always give the true picture. There are other aspects of your accounts that the companies look at. Your credit utilization ratio makes it easier for lenders to understand how much debt you have. They determine this by comparing your overall debt to your available credit limits.
An individual with a balance of $100 on a credit card with a $550 limit seems responsible. On the other hand, someone with $350 balance on a similar credit card would be considered risky.
4. A mix of different credit types
Another thing that’s considered while determining your credit score is whether you have a mix of different credit types. It means that you must have different types of accounts such as credit cards, instalment loans, and store accounts.
This doesn’t mean that you must open new accounts just to increase the accounts in your credit profile. You don’t need to worry if you have lesser types of accounts. This is just a small component of your credit score.
5. New credit
The number of new accounts you’ve applied for recently is also considered while determining your score. Whenever an application is sent by an individual for a new line of credit, a hard inquiry is done. If you’ve opened several new accounts and their percentage is high, you’re considered a risky borrower.
The lenders assume that you might be experiencing cash flow problems. Many people accumulate debt to ensure a good cash flow, which becomes a problem later on.