calculate credit score

How Consumer Credit Scores are Calculated

What Does the Typical US Consumer Know About Building Credit?

It’s safe to say not enough. Understanding how to build credit and how credit scores are calculated is a priceless benefit to those who want to optimize their financial well-being and overall personal finance behaviors.

In today’s consumer finance market credit is king (not cash). You can’t get a credit card or rent an apartment without a good credit score these days. Those with high credit scores are rewarded with great promotional deals and superior reward programs that can truly make a big impact on your personal savings year over year. This sort of financial advantage can make the difference between retiring at 58 or working till 76.

When applying for a housing loan, having a high score can save you a fortune. Fortunately, once you know how it is calculated, building and maintaining a good credit score won’t be so difficult.

Your Credit score can range from 300 to 850. It’s made up of the following parts:

5 Important Variables Used to Calculate Your Credit Score

  1. History of Payments 35% – What does your credit history look like? Are your payments for credit cards and loans always on time?
  2. The amount of Debt 30% – If the money you owe doesn’t even amount to 10% of the credit you have, your score will be high.
  3. The length of credit history 15% – The amount of time your accounts have been open is actually quite vital to your score.
  4. Types of credit 10% – What types of credit are you still paying off? Do you have credit cards, student loans, personal loans, etc.? Is the debt secured or unsecured? Is it high interest or low interest?
  5. New accounts 10% – Every time you open a new credit card account, your score suffers. Fortunately,the score will bounce back and recover in about a year.

 

Building Good Credit

You only need one credit card to start building credit. Keep up with the payments to build a good score and become qualified for more credit card applications and loans. While it can be tempting to sign up for store credit cards and avail of “once-in-a-lifetime” rewards, it’s best to say no. Their interest rates and fees are usually high, plus there’s also the risk of you forgetting to pay off your monthly balance and thus damaging your credit score.

When you’re still starting out, don’t apply for cards that require high scores just yet. You’ll have a much better chance of getting approved if you get your first credit card through your bank, especially if you’ve been a member for a long time.

If you get rejected, don’t worry because you can reapply through reconsideration lines. It’s also possible to apply for a secured card that requires you to deposit cash up-front as a card limit. After about eight months, the company may offer an unsecured credit card that works just like a regular credit card.

At some point, you might feel that you need more spending power. Thankfully, you can contact the credit card company for a credit limit increase. This will not only let you spend more, but also boost your score. It’s best to do this when your card has been with you for at least a year and you’ve successfully kept up with the payments.

Keep in mind that failing to pay before the due date will hurt your score. Of course, late payments and delinquency are bad news, but they are not permanent. Thankfully, you can call the company about your overdue bill and negotiate to have it removed if you pay in full.

If you get to a point where you just can’t keep up with even the minimum credit card payments then you may want to settle your debt which will typically allow you to get rid of 40-60% of your outstanding credit card debt balance. This notion makes debt settlement sound great but this strategy comes with big consequences and will destroy your overall credit score. The other debt solution that can help you obtain debt relief is filing bankruptcy. Bankruptcy may allow you to eliminate all unsecured consumer debt such as credit cards and other personal loans. This debt solution also has its consequences which also include a badly damaged credit score.

Remember that having multiple credit cards won’t give you the highest score. Unless you’re already knee-deep in debt, you should consider applying for a loan or two. Taking out a small personal loan and then paying it off on time will not just increase your score, but also leave a good impression on the company.

With great power comes great responsibility. Use your spending power wisely and be smart about loans, so you can build credit and save a fortune when you’re older.

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