If you plan on getting a loan, understanding your financial health and particularly your credit score is important. Your credit score is one of the essential factors that determine your financial health. It determines your ability to borrow money and whether you will be able to secure a loan with favorable terms and conditions.
Banks prioritize good credit scores if you want to avail of their financial opportunities with a lower rate of interest and favorable terms. In this article, we will look at how a credit score is calculated and how it impacts your borrowing capabilities.
What Is a Credit Score?
A credit score is a three-digit number that indicates your creditworthiness. Your credit score is based on your credit history and financial behavior. To get a loan, you need a good credit score. Traditional banks do not consider individuals with low credit scores to be good prospective borrowers, and hence, they may not offer favorable rates. Contrary to this, other financial institutions, such as Safe 1 Credit Union, are more likely to offer you a loan even in such circumstances.
Your credit score ranges from 300 to 900. Here is how it is categorized:
- Exceptional: Between 800 and 850
- Very Good: Between 740 and 799
- Good: Between 670 and 739
- Fair: Between 580 and 669
- Poor: Between 300 and 579
Generally, a credit score above 670, which is in the “Good” range (670-739 for FICO), is considered safe by lenders, and you can obtain a loan with favorable terms.
What Factors Determine Credit Score?
Here are the factors that determine your credit score:
1. Payment History
How punctual you are in paying your bills is an essential factor in determining your credit score. Your payment history helps lenders determine whether you can repay your loans on time.
Paying your loans on time consistently builds confidence among the lenders that their money is in safe hands. Alternatively, missing or delayed payments make a negative impression on your lenders and also impact your credit score.
2. Credit Usage
Credit usage consists of three factors:
- Credit utilization: Credit utilization is a percentage that shows how much credit you are using relative to your total credit limit. For instance, if your total credit limit is $1000 and your outstanding balance is $300, your credit utilization percentage is 30%. Optimizing your credit utilization ratio is important for a good credit score.
- Total balances: Total balances are the sum of all outstanding amounts you currently owe across your credit accounts.
- Available credit: This is the portion of your total credit limit that you can still use.
3. Credit Depth
Credit depth is a combination of two factors: length of credit history and account mix.
- Length of credit history: The more experience you have with handling credit accounts, the better you will manage debts. Hence, a longer credit history leads to a higher credit score.
Your length of credit history is evaluated by measuring the age of your oldest credit account, the newest credit account, and the average of all the credit accounts.
- Account mix: It is the variety of credit accounts you have on your credit report. This includes revolving credits, such as credit cards, and installment credits, such as personal loans and auto loans.
4. New Credit
New credit refers to any recently opened credit account or recent credit inquiry shown on your credit report. A new credit includes the following:
- Applying for a new credit card
- Taking a loan (personal loan, auto loan, or home loan)
- Hard inquiries made by lenders
Multiple hard inquiries in a short timeframe can reduce your credit score by a few points.
Start Improving Your Credit Score
Your credit score is mainly influenced by two factors: payment history (40%) and credit usage (34%). This is why if you want to protect your financial health, you must pay your bills on time and take credit wisely.
By following these two factors, you prove yourself to be a responsible borrower and can build trust with lenders. Additionally, don’t let a low credit score stress you out. Although financial banks may not provide you a loan in such circumstances, a credit union offers loans even with lower credit scores. So, make sure to inquire about the possibilities.