Understanding Your Credit Score
Before you can begin to repair your credit score, it’s important to understand what factors affect it. Many people don’t realize that there are a number of specific things that affect your overall credit score. If you don’t pay attention to all of them, you can unknowingly hurt your score.
Your credit score will range between 300 to 850 and represents how likely you are to pay back money you have borrowed. In the eyes of lenders, the lower your score, the less likely it is that you’ll repay the funds you’ve borrowed.
This is why it’s so important to build your credit score. If you have a low score, lenders will be very hesitant to give you money. If your score is under 560, you are considered to have “bad credit”.
There are five factors that determine your score. In order of importance, they are:
- Payment history. Paying bills on time is really important for your overall credit score. Late payments, having accounts sent to collections agencies, or defaulting on accounts will significantly hurt you. Bankruptcy is also very damaging to your score.
- Credit usage. Credit usage is how much of your available credit you’ve used. For example, if you have a credit card with a $10,000 limit and you have a $3,500 balance on the card, your credit utilization rate is 35%. A low credit utilization rate is better for your credit score.
- Credit mix. Typically, it’s better to have experience with different types of credit than with just a single category. All things being equal, a person who has managed both a home loan and a credit card will probably have a higher score than someone who has only had a credit card.
- Age of accounts. Creditors like to see that you’ve had credit for some time, not just new accounts, so older accounts generally help raise your score.
- Credit applications. When someone examines your credit record to determine whether to give you credit, it’s called a “hard inquiry”. Hard inquiries can lead to a decrease in your credit score.
As you work to increase your score, keep these five factors in mind. Focus on the things that have the biggest impact on your score.
It’s also important that you understand the different types of consumer credit available to you.
Generally speaking, there are four types of credit:
- Revolving credit, such as credit cards, allows you to borrow up to a certain amount every month. You are not required to pay back the full amount by the end of the month, but the longer the balance is unpaid, the more interest is added.
- Charge cards are essentially the same as credit cards except you are required to pay the balance in full at the end of each month.
- Service credit is when a person provides you with a specific service and then bills you after the fact. Everything from your cell phone bill to utilities is considered service credit.
- Usually, service credit doesn’t show up on credit reports. However, if you fall behind on paying these bills, it could be reported to credit bureaus or sent to collections, which does affect your credit score.
- Installment credit comes in the form of loans. You borrow a specified amount of money and then repay it over the life of the loan.
Now that you understand the basics of what goes into your credit report, let’s get started with the steps you can take to repair your credit and raise your credit score.
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