Have you ever wondered how lending institutions or banks decide whether to grant a person or business a loan? They consider many factors, the main one being your FICO credit score. The credit score is an automatic system that provides a three-digit numeric score based on given information.
The three-digit number is based on previous credit experiences, such as payment history, collection actions, or outstanding debts. Once this number is shared, banks and lending institutions will have pre-established thresholds that will determine approval, interest, and loan amount.
Using a statistical program, credit grantors compare this information with the payment history of other consumers with similar profiles and “predict” the ability of the credit applicant to pay. The most popular credit scoring system is the FICO score, a type of credit rating that the Fair Isaac Corporation created. It is estimated that around 90% of financial institutions rely on this system for their credit score.
Good credit history is essential to obtain approval of credit cards, mortgage loans, and auto loans, among others. The credit history and the score also determine the interest rate that will have to be paid in the credit accounts. Thus, people with excellent credit history may have approved their loans with preferential interest rates. In contrast, those with a bad history will pay higher interest due to their more significant risk of default.
What factors determine the credit score?
The credit scores are generally based on the following factors to give your score:
- Payment history. It refers to whether an individual pays their credit accounts punctually or not. The shorter the time in which payments are made, the more score is obtained in this parameter. It is the factor that contributes the most to the FICO score, 35% of the total score.
- Accounts owed. It refers to the available amount of money a person owes. Consider the proportion of money owed to the total credit available. This factor contributes to 30% of the FICO score.
- Duration of the credit history. The longer the credit history, the higher the score of this factor. It considers the oldest account’s time, the age of the most recent account, and the general average. This factor contributes 15% of your FICO score.
- New credit accounts. Refers to recently opened accounts. If the borrower has opened many credit accounts quickly, it could become a high risk for the lenders. This factor contributes to 10 percent of the FICO score.
- Credit mix. It refers to the amount and variety of credit accounts that the person has. To obtain high credit scores, it is necessary to have a solid mix of accounts, credit cards, credits, etc. This factor also contributes to 10 percent of the FICO score.
What is a good credit score?
The credit scores typically range from 300 to 850. The higher the score, the better the chances of obtaining good credits.
Within the range of 300 to 850, there are different categories of scores, which generally include:
- Below 600 points: bad credit
- Between 600 and 649 points: poor credit
- Between 650 and 699 points: fair credit
- Between 700 and 749 points: good credit
- 750 and more points: excellent credit
Therefore, it is recommended that our credit rating is above 700 or 725 points.
However, it is necessary to specify that different lenders can use different credit scores so that one score that a lender considers as good, for another, could be a fair or poor credit.
How can I improve my credit score?
As we have seen, the credit scores are complex and may vary depending on the credit grantors, but generally, these are some of the aspects that must be considered to improve the credit score:
- Paying bills on time is one of the most important aspects to have a good credit score. If you fall behind in some payment for a problem or forget, get up to date as soon as possible, and the rating will improve gradually.
- If you find it challenging to deal with your debts, contact your lender and try to negotiate them or, if applicable, request an increase in the line of credit.
- Always consider the quotas of your credit cards and consistently seek to be below the maximum allowed.
- Contrary to what is usually thought, do not close old credit accounts, contrary to what is usually thought, helps improve the credit score. The longer you have your accounts, the more you add to your score.
- After acquiring new debt, wait a prudent time before requesting another loan so that your cash flow adapts to the new obligation.
- Contrary to popular belief, checking the credit history does not decrease the score. It is essential to review it at least once a year to avoid unpleasant surprises when you make a significant investment.
So, it is essential to be aware of the factors that affect our credit score since this will depend significantly on granting the credits that we need to obtain. Making debt payments on time and not having large amounts owed is essential for a good credit score.
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