What Is A Credit Score And How Is It Calculated? | New Horizon (2024)

Credit score is a three-digit number that indicates your likelihood of repaying loans and making payments on time.

Having a high credit score best demonstrates that you are a responsible individual who has consistently met your financial obligations. Creditors are more confident that you will repay your future debts and it also means that businesses regard you as less of a financial risk, which indicates you’re more likely to obtain credit or pay less for it.

Credit scores are computed using a formula that considers factors such as payment history (35%), amount owned (30%), length of credit history (15%), credit mix (10%) and new credit (10%).

Payment History

As it appears, your payment history is the most important factor in determining your credit scores. It accounts for 35% of your total score. This shows whether you pay your bills on time, how often you miss payments, how many days past the due date you pay your bills, and how recently payments have been missed.

The considerations include how far behind you are on a bill payment, the number of accounts with late payments, and whether or not the accounts have been brought current. The higher your percentage of on-time payments, the higher your score. Payments that are more than 30 days late will typically be reported to your lender and every time you miss a payment, your credit score suffers.

Amounts Owned

Amounts owed come second in importance to payment history when determining credit scores. In this component, credit scores focus on the current amount of debt, how much you owe on loans and credit cards, and it accounts for 30% of your score.

The credit utilization ratio is the most important factor to consider. Credit scoring models assume that borrowers who consistently spend up to or over their credit limit are a potential risk, high balances and maxed-out credit cards will lower your credit score. It is preferable to keep your utilization under 30 percent.

Length of Credit History

The length of your credit history accounts for 15% of your score. When considering credit history, credit scoring models typically consider the average age of your credit.

Responsibly managing credit accounts over time can improve your credit score, which is why you should keep your accounts open and active.

The longer of making on-time payments, the higher your credit score will be. It may appear sensible to avoid applying for credit and carrying debt, but doing so can actually harm your credit score if lenders do not have a credit history to review.

Closing a credit account, on the other hand, will diminish your overall credit, which may have a negative impact on your credit scores.

Credit Mix

Having a variety of accounts, such as house loans, installment loans, mortgages, and retail and credit cards, can help you improve your credit scores. This accounts for 10% of your total score. Lenders prefer to see a healthy credit mix that demonstrates your ability to manage various types of credit. Both revolving and installment credit should be reflected, if possible.

New Credit

Makes up the final 10%. People who open a large number of new credit accounts in a short period of time are considered high-risk borrowers.

Too many credit applications can indicate that you are taking on a lot of debt or that you are in financial distress. And opening a new account can have an impact on other aspects of your score, such as the average age of your accounts. Start with one credit account and go from there.

Frequently asked questions about credit scores

What is a good credit score?

In 2021, many lenders started looking for a higher credit quality than previously. This happens every time there is a downturn in the economy. You must have a 700 FICO or above to be considered a “good credit risk”

What is the highest credit score you can have? The highest FICO and Vantage Score you can have is a 850. Making 850 a “perfect credit score”

What is the lowest credit score you can have?

The lowest FICO and Vantage Score you can have is a 300

Is 600 considered a good credit score?

Unfortunately not. It used to be looked at as ok or fair. But recently more and more lenders are charging people with under a 700 credit score higher interest rates. At a 600 you MAY BE approved, but it won’t be at the promotional rates they advertised. The credit limit given will also probably be lower.

Why did my credit score drop?

There are a number of reasons why your credit score can drop. You need to get copies of all 3 credit reports and see what’s going on.

• You could have started using a lot more of your credit.
• Someone may have reported a late payment.
• There can be an error on your credit report.
• You may be using more credit OR one of your lenders reduced the amount of credit they gave you, thus making it look as if you are using more credit than you previously had been.
• Did you apply for credit recently? A hard inquiry can temporarily drop your credit score. If you need more credit. Look for lenders that use a soft inquiry.
• Did you miss a payment? Look thru all of your bills and make sure they were all made. Check your banks bill payment to make sure all payments were made and none returned.
• Did you recently close a credit card? You shouldn’t always close an account just because you paid it off. It may have been a cornerstone of your credit score and your score can suffer if you close the wrong accounts.
• Perhaps you paid off an installment loan or mortgage. That’s a good thing and it can be a bad thing. Paying off installment debt can have a negative effect. It will impact your credit diversity. But on the positive side, paying off debt is good for your financial health. You will lose only a few credit score points but gain a lot of peace of mind!

Where does your credit score start at?

Well, that depends. As you read above, there are a lot of factors that go into creating your credit score. You don’t start off with 0 or 300. Once you start to build your credit file, your score will start to build based on your actions.

If you follow good credit habits, you will see a good score. Even if you only have a few new tradelines. I’ve had clients with 2 tradelines and 700+ credit scores. While I’ve seen a few with 2 tradelines and scoring in the 500s.

It’s all based on your habits and who starts reporting. If you have little or no credit. Be very deliberate in how you handle your credit.

In conclusion, understanding what makes up your credit score can be beneficial in building or rebuilding your credit. By knowing the factors that go into your score, you’ll be able to decide what to change in order to improve it.

Have a question about your credit score? Feel free to contact us! We will answer your question and add it to our frequently asked questions about credit scores and reporting here on newhorizon.org!