How Your Credit Score Is Calculated
There are multiple credit score methodologies. Two companies create the FICO and VantageScore credit scores. The three credit companies, Experiean, TransUnion, and Equifax also generate credit scores. They all use proprietary formulas but the scores are pretty close.
Payment History
Your payment history accounts for approximately 40% of your credit score. Lenders connect how often you pay bills late with how you are likely to pay bills in the future. If you have a lot of late payments, then they are hesitant to lend you money. Their concern is that you make late payments on a regular basis and will not pay them on time. This section of your credit score also includes bankruptcies, foreclosures, accounts sent to collections, defaulted accounts, and instances of wage garnishment. Your payment history lets lenders know what the chances are of you paying them back.
Credit History
How long you have had your credit account tells lenders how experienced you are at handling credit. This section is about 21% of your overall score. Lenders like to see a history of you paying off your debts.
Credit Usage
This number reflects how much of your credit you are using. It accounts for approximately 20% of your score. Lenders like to see that you don’t use all of your available credit. Maxing out your accounts indicates you may be spending beyond your means to pay them off.
Total Balances
Another sign lenders interpret as you spending beyond your means is the total of all your loans is high. This accounts for about 11% of your credit score. If you have a high total of all balances, lenders are not going to be eager to add to that number.
Credit Check
When someone checks your credit report as a result of you applying for a loan, credit card, or another form of credit, this gets noted on your credit report. If you are shopping around for a mortgage or a car loan, these inquiries all get grouped into one request as long as they are within a certain period of time, usually two weeks. Lenders don’t have a problem with you looking for the best loan. They do have concerns if you keep trying to get more credit. This section accounts for about 5% of your credit score.
Available Credit
The more available credit you have, the higher the score in this section. This section accounts for about 3% of your overall credit score. Lenders like to see you have available credit. It shows that you do not max out all of your accounts and that you handle credit responsibly.
Other Factors
There are other factors that go into calculating the credit score. How many new accounts you added over the past two years, as well as how much you have paid down on loans, including real estate loans, also shows lenders how you handle credit. If you keep refinancing loans for the ability to cash out or you keep getting the credit limit increased, this indicates to lenders that you are shuffling debt around rather than paying it off.
Myths About Your Credit Score
There are some myths floating around out there about how credit scores are calculated.
- Closing a credit card will help you credit. This one is not true because closing a credit card will affect your credit history. You want to keep these accounts open to show lenders that you don’t just use all the credit you have available but you borrow wisely.
- You need to take on debt to have a good credit score. You need to have a credit history, not necessarily outstanding debt for a good credit score. You can open a credit card, use it once, pay it off, and not use it again. This will establish your credit history.
- Spreading out your credit card debt helps your credit score. Your credit score is calculated using the total amount of debt you have vs. the total amount of credit you have. Spreading out your credit card debt doesn’t make a difference in this calculation. It will give you a bunch of minimum payments to make that might add up to an amount that would be better spent paying down fewer debts with larger payments.
- You have just one credit score. As we discussed above, there are multiple companies calculating credit scores based on their own formulas.
- Checking your credit report will hurt your credit score. When you check your credit report, this is known as a soft inquiry. It will not affect your credit score. A hard inquiry is recorded on your credit report. Hard inquiries are when lenders check your credit in response to an application you have submitted for a line of credit or loan. These get recorded on your credit report.
Tracking Your Spending: the Next Step to Paying Down Debt and Increasing Your Credit Score
You might be wondering why you run out of money before your next paycheck. In order to pay debt down faster, you need to identify some extra money you may be letting run through your fingers without realizing it.
Track Everything You Spend on One Day
Make a list on a sheet of paper, in a small notebook, or a spreadsheet on your phone of every single thing you spend money on in a day. Create this list as you go along so you don’t miss anything. Write down what you bought and, in the next column, what you spent. At the end of the day, next to each item, put a check mark if that item is something that you didn’t need to spend money on. For example, are you grabbing breakfast at a drive through rather than eating at home? This is extra money you could be saving. Or, are you buying bottled water instead of refilling a water bottle? Are you spending money on lottery tickets? Put a check mark next to each expense that could be deemed money better spent elsewhere (such as debt reduction). At the bottom of the page, total the amount of each item with a check mark.
Think about how much you lose if this is a typical day’s expenditure. Multiply that number by 30. This is what you spend in a month on things you don’t need. Or, multiply that number by 365 to see what one year’s wasted expenses is. If you take that daily number and multiply it by 3650, you get the amount of money you waste on unnecessary items in ten years. You might even consider how much you would have if you invested that money for 10, 20, 30, or 40 years. Do those things you bought suddenly seem less worth it?
Checking Your Credit Report for Errors Affecting Your Credit Score
Look over the free credit report you obtained. Check to see if there is anything wrong. This could be money you don’t owe, wrong names you never used, addresses you never lived at, or bills that were paid on time but marked as late. Contact the credit agency about anything you want to dispute on your credit report. They will let you know what the process is for disputing errors on your credit report. Fixing errors that shouldn’t be on your credit report can be one of the easiest ways of improving your credit score.
Pick One Thing Affecting Your Credit Score to Improve
Look at your credit report. There is probably one thing on it that you can improve starting now. You may be paying bills late. You may have too much debt, Pick one of these things that you want to work on. For example, if you are making payments late, come up with a plan to pay your bills on time. Pay all of your bills on payday and then you won’t run out of funds when they are due. Or, set up reminders on your phone so you don’t forget to pay them. If you want to decrease your amount of debt, consider putting the amount you discovered you wasted in the above exercise toward debt reduction.
Taking Control of Your Finances
After completing these three things, you should have a better sense of being in control of your finances than you did before. Doing something, even something small, will always feel better than doing nothing about an existing problem. TGUC Financial can help you with credit repair. Contact us today and let us help you raise that credit score.
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