A credit score is a number that lenders use to determine the risk of loaning money to a given borrower. Auto dealerships and mortgage bankers are common examples of types of lenders that will check your credit score before deciding how much they are willing to lend you and at what interest rate. Insurance companies, landlords, and employers may also look at your credit score to see how financially responsible you are before issuing an insurance policy, renting out an apartment, or giving you a job.
In this article, we’ll explore the biggest factors that have an impact on credit scores.
What counts towards your score?
Your credit score shows whether you have a history of financial stability and responsible credit management. Based on the information in your credit file, credit agencies compile your scores for the system major bureaus use. Each agency will report a slightly different score, but they should all paint a similar picture of your credit history. Here are the elements that make up your score and how it affects your credit:
The most important component of your credit score looks at whether you can be trusted to repay funds that are lent to you. This component of your score considers the following factors:
- Have you paid your bills on time for each account? Paying late has a negative effect on your score
- If you’ve paid late, how late were you – 30 days, 60 days, or 90+ days? The later you are, the worse it is for your score
- Have any of your accounts gone to collections? This is a red flag to potential lenders that you might not pay them back
- Do you have any debt settlements, bankruptcies, foreclosures, lawsuits, or public judgments against you? These items of a public record constitute the most dangerous marks to have on your credit report from a lender’s perspective
- The time since the last negative event and the frequency of missed payments affect the credit score deduction. For example, someone who missed several auto loan payments five years ago will be seen as less of a risk than a person who missed one big payment this year
This second component looks at the following factors:
- How much of your total available credit have you used? Don’t assume you have to have a R0 balance on your accounts to score high marks. Less is better, but owing a little bit can be better than owing nothing at all because lenders want to see that if you borrow money, you are responsible and financially stable enough to pay it back
- How much do you owe on specific types of accounts, such as mortgage and auto loans? Credit scoring software likes to see that you have a mix of different types of credit and that you manage them all responsibly
- How much do you owe in total, and how much do you owe compared to the original amount on the installment account? Again, less is better
Length of a credit history
Your credit score also takes into account how long you have been using credit. For how many years have you had obligations? How old is your oldest account, and what is the average age of all your accounts?
A long credit history is helpful (if it’s not filled with late payments and other negative items), but a short history can be fine, too, as long as you’ve made your payments on time and don’t owe too much.
This is why it is always recommended to leave accounts open, even if you don’t use them anymore. The account’s age by itself will help boost your score. Close your oldest account and you could see your overall score decline.
Your credit score includes how many new accounts you have. It looks at how many new accounts you have applied for recently and when last you opened a new account.
Whenever you apply for a new line of credit, lenders typically do a hard enquiry, which is the process of checking your credit information. This is different from a soft enquiry, such as when you retrieve your own credit information.
Hard enquires can cause a small, temporary decline in your credit as the score assumes that if you’ve opened several new accounts recently, you could be a greater credit risk. This is due to the thinking that people tend to open many new accounts when they are experiencing cash flow problems.
For example, when you apply for a mortgage, the lender will look at your total existing monthly debt obligations as part of determining how much mortgage you can afford. If you have recently opened several new accounts, this might indicate that you are planning to go on a spending spree in the near future, meaning that you might not be able to afford the monthly mortgage payment the lender has estimated you are capable of making. Lenders can’t determine what to lend you based on something you might do, but they can use your credit score to gauge how much of a credit risk you might be.
Types of credit in use
One of the final things to consider when determining your credit score is whether you have a mix of different types of credit. It also looks at how many total accounts you have. Since this is a small component of your score, don’t worry too much if you don’t open a variety of new accounts.
What isn’t in your score
The following information about a person is generally not considered in determining your credit score:
- Marital status
- Race, colour, religion, national origin
- Occupation, employment history, and employer (though lenders may consider this)
- Where you live
- Child/family support obligations
- Any information not found in your credit report
What it all means when you apply for a loan
Following the guidelines below will help you maintain a good score or improve your credit rating:
- Pay your accounts on time, and if you have to be late, don’t be more than 30 days late
- Don’t open lots of new accounts all at once or even within a 12-month period
- Check your credit score about six months in advance if you plan to make a major purchase, like buying a house or a car, that will require you to take out a loan. This will give you time to correct any possible errors and, if necessary, improve your score
- If you have a bad credit score and lots of flaws in your credit history, don’t despair. Just start making better choices and you’ll see gradual improvements in your score as the negative items in your history become older
The bottom line
While your credit score is extremely important in getting approved for loans and getting the best interest rates available, you don’t need to obsess over the scoring guidelines to have the kind of score that lenders want to see. In general, if you manage your credit responsibly, your score will shine.
In order to see where you stand, in terms of your credit score, contact MarisIT and we will assist you with your credit score report.