If you have been wondering how credit scores work, hopefully this will help to demystify an important but often confusing topic. We will go through a very brief discussion of 5 main factors that can affect your credit score. All have an impact on the credit score scale.
The first and foremost factor that affects credit score is your payment history. Making timely payments on outstanding accounts is critical to maintain or improve credit rating. Late payments are reported, and anything 30 days late or more will have a greater negative effect. If you are having trouble paying down debt, at least pay the minimum balance on time, and they you can make additional payments as you are able without being penalized for paying late.
Another factor that affects credit score is the number of open credit accounts. This does not mean you should close all of your open credit cards. Credit cards hold account history on them, which means that if you have made payments on time for 5 years on a certain card, all 5 of those years have an effect on your overall credit score. This also means that if you close that account, those 5 years of good credit go away. When you are trying to maintain or improve your credit rating, however, you should not open any more cards or apply for any new debt. Also be aware that closing an account with a bad history will not necessarily get rid of the negative effect from that history.
A third factor that affects credit scores is the total length of time you’ve had credit history. The longer history you have, the better picture a potential lender can get of what type of risk you are to them. Your credit report is basically showing how risky you are from an investment standpoint. The higher your credit rating, the less risk an investor takes by lending you money. Lower scores indicate higher risk due to any negative factors, including default, bankruptcy, late payments etc.
The fourth factor affecting credit scores is how many inquiries you have had on your credit file recently. Too many recent inquiries tells a lender that you may be applying for more credit lines, which means you may be racking up more debt that hasn’t been reported yet. If you have not opened a new account for an extended period of time, a lender is more comfortable that you have adjusted to your existing payments and will be able to pay back any loan they give you according to the agreed upon terms.
The last factor that we will discuss is the total amount of debt that shows on your credit report. Credit reporting agencies will show your total financial liability, and lenders will use this figure compared to your income to decide if you are solvent. The lower the debt to income ratio is, the less risky you become because you theoretically have enough income to comfortably pay your required monthly payments. In short, to maintain or improve your credit rating, you should be aware of your payment history, number of open accounts, total length of credit history, recent inquiries, and debt to income ratio.