Most lenders use the Fair Isaac and Company or FICO score to determine your overall creditworthiness. Your score is expressed numerically from 300 to 850--with 850 being the best--and takes several factors into consideration. Generally speaking, the higher your score, the less likely it is--from a statistical perspective--you will default on your loans. If you are concerned with building up your credit score to have the best possible chance of obtaining favorable financing, consider the five critical factors FICO uses to calculate your score.
Payment History--35 Percent
When it comes to your creditworthiness, lenders are most concerned with your ability to service your outstanding balances in a timely and effective fashion. Late payments and other delinquencies carry significant weight when calculating your credit score. If you want to improve your credit score, make your payments on time and avoid falling behind, repossessions or writing off balances--these are major red flags to creditors and have significant downside effects on your credit score. If you have a history of late payments, making an immediate change in your behavior will help tremendously. FICO gives more weight to your payment history over the past 12 months than it does from times prior to that.
Debt Utilization--30 Percent
Creditors get nervous when you have fully tapped out your borrowing capacity and available credit lines. This means you have borrowed to the maximum allowed and statistically, your chances of default are higher if you encounter a drastic change in your income. It is important to use your available credit to establish a credit history, but if you are maxing out your lines, it will reflect poorly on your credit score. Paying down balances and accepting higher credit limits when awarded will help improve this component of your credit score.
Credit History Length--15 Percent
The longer you have had credit, the better it reflects on your credit report and score. If you rarely or never use the first credit card you received several years ago, consider making a small purchase on the card just to keep the account active. If your oldest credit account is closed, your credit history length will be reduced to reflect your second oldest, active account. Lenders like borrowers with longer credit history as it provides greater insight into the consumer's behavior versus someone that just opened 10 new accounts in the past week.
New Credit Inquiries--10 Percent
Each time you apply for new credit or request a credit line increase, an inquiry is made to your credit account. Similar inquiries may also be made when renting an apartment, applying for a job or opening a new bank account. If you like to apply for each credit card you receive an application for, you may rack up an unnecessary amount of inquiries that can have a slight drag on your credit score.
Other Items--10 Percent
Creditors like to see a broad mix of credit accounts, including credit cards, mortgages and other installment loans such as automobile loans. If you only have a home mortgage, applying and getting approved for an unsecured credit card can ultimately improve your score. However, applying for different types of credit just to maximize this component of your score is not advised.
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