Credit is crucial in a number of areas of life, whether you’re trying to score a student loan, buy furniture or appliances, or purchase a car or home. You have a three-digit number — your credit score — which often determines whether you can even make these decisions and how much it is going to cost.
Your credit score is based on your credit report, which is a list of all of your debt records over time. Whether you’ve paid your credit cards and mortgages on time, had accounts with vendors go into collections and paid your car note punctually all appears on that report, and the credit score reflects how a credit bureau takes all of that information and calculates your creditworthiness. If you’ve ever wondered how you can apply for a credit card online or apply for a department store credit card at the counter.
Several different methods go into generating a credit score, but the majority of lenders use the FICO method, a proprietary tool of the Fair Isaac Corporation. Your credit score ranges between 300 and 850. The precise formula is a proprietary secret that Fair Isaac holds onto, but here’s an approximation of the process. 35 percent of your score comes from your history of making payments. This has the most weight, which makes the most sense because lenders want to see whether you pay your bills or not. The number of bills that you have late is important here, as are any bankruptcies and the number of accounts you have in collections.
30 percent comes from your total outstanding debt, or the money you still owe on existing mortgages, car notes and credit cards. One thing to remember about credit cards is that keeping your balance at or below 30 percent at any given time is key. It’s best to pay it off each month, but you want to have a record of using your cards and paying them off. Signing up for credit cards and leaving them in a drawer does not help your score as much as using it and paying the monthly balance, even though you are at 0 percent each month either way.
15 percent of your score comes from the time you have had access to credit. The longer time you have access to credit, the better this looks for you.
10 percent comes from new credit, like opening new accounts, which actually drives your score down for a short time until you establish a solid payment history. Hard inquiries by lenders into your credit also hurt your score if you do too many in a short time.
The final 10 percent comes from the different types of credit you have. Success with mortgages and car notes and credit cards helps you more than just success with a mortgage, for example.
Understanding how your credit history contributes to your credit score is important as it helps you establish your spending priorities so that you are in a position to gain access to financing when it’s time to make major purchases, like a new home.
Understanding Credit Score – (https://www.fcac-acfc.gc.ca)
PDF – Understanding Your Credit Report and Credit Score – (https://www.fcac-acfc.gc.ca)