What is a credit score?
A
credit score is a three-digit number that sums up your credit report. Lenders
use your credit score as a quick guide to decide whether or not to lend you
money and at what terms. People with high credit scores have solid credit
histories and are, therefore, considered low-risk borrowers. They get the best
interest rates on credit cards, mortgages and other types of loans. People with
low
credit scores have either patchy credit histories, or none at all. They are more likely to be
turned down for a loan. If they do get approved, it will be at a higher interest
rate.
How is your credit score calculated?
Your credit score is calculated using a complex mathematical formula that takes into account all of the things that make up your credit history. This includes debts, payment histories, court judgments, bankruptcy filings and much more. Different credit bureaus use slightly different formulas, resulting in slightly different credit scores.
Video: How to Calculate Your Credit Score
Types of debt
Installment debt – Installment debt is the type debt that has to be repaid as a series of fixed payments over a specified period of time. This includes mortgages and car payments. You pay back the same amount every month for a set number of months (or years). If you have this type of debt, it will show up on your credit report prefaced for the letter “I”, for “installment.”
Revolving debt – Revolving debt includes credit cards and store cards. The payments on this type of debt depend on the current balance on that account. They vary from month to month, depending on how much you owe. Revolving debts will be listed on your credit report prefaced by the letter “R.”
Open debt – With open debt, you run a balance on the account until you receive a bill. You then have to pay the bill in full. A cell phone contract is an example of this type of debt. Open debt will be listed on your report prefaced by the letter “O.”
Video: Understanding Your Credit Score
How different types of debt influences your credit score
The actual formula used to calculate your credit score is very complex. However, there are general guidelines that can tell you how the different types of debt are weighted. The most important part of your credit report is your payment history. It accounts for approximately 35% of your credit score. Missed and late payments will reflect badly on you as a credit risk. Open debt accounts for another 30% of the sore. Do not borrow more than you need. Someone who is already heavily indebt is potentially a huge risk. Another 15% is the length of your credit history.
Younger people often have trouble getting a credit card or a loan because they have no credit history. The lenders have no way of knowing whether these people are capable of making regular payments on their debts. If you have insufficient credit history try building it up by getting a store card, just make sure that you keep up with the payments.
Another 10% is new credit, which includes the number of recent credit enquiries. The final 10% is the type of credit you have used, including mortgages, car loans, credit cards, bank loans, etc. It’s good to have a wide variety because it shows that you can make payments on different types of loans. However, if you have too many, you may still be considered a high-risk borrower.
