What Factors Determine a Credit Score?

Credit ScoreA credit report is the key factor that any lender, including credit card companies, mortgage brokers, car dealers and banks, will examine to determine whether to extend credit to a potential borrower. Credit reports are also used by landlords, insurance companies and potential employers.

Essential to the credit report are the five key elements that make up one’s credit score. Lenders analyze all factors and then look at the credit score to gauge the risk involved with lending money. These factors are the borrower’s payment history, amounts the borrower owes currently, length of credit history, new credit and the types of credit the borrower is using at the time.

The largest of the five factors, the borrower’s payment history accounts for 35 percent of the credit score. This is a look at all debt a borrower has ever held and how well they managed that debt. Crucial to this history is whether bills were paid on time. Paying bills late negatively affects credit score. The next question is how late the bill was paid. The longer the bill went unpaid, the more severe the credit score penalty. The creditor will also check if any accounts have been referred to collections, or if there have been any settlements or bankruptcies. All these factors will lower the credit score.

The second largest factor, accounting for 30 percent of the credit score, is the total amount currently owed. Of a borrower’s available credit, how much is already being used, both individually per account and in total. Borrowers must strike a balance in this category to achieve a good score. They must have some debt, as it proves they are able to manage their financial obligations, but they shouldn’t have so much debt that extending another line of credit would look like a bad idea.

At third, length of credit history represents 15 percent of a credit score. This doesn’t just mean how long the borrower has been taking out credit. It also factors the ages of individual accounts. While it may seem a long history would be advantageous, borrowers with a short history of on-time payments to accounts that aren’t over-extended will do fine.

Next, at 10 percent, is new credit. Like the name says, this facet of the overall score analyzes how many accounts a borrower has opened recently. Lenders assume that borrowers with many new lines of credit are having issues with cash flow and are using credit to cover their shortfalls. This is obviously the mark of a distressed borrower and banks are wary of anything that points to an inability to pay a prospective loan.

The final 10 percent is represented by the types of credit a borrower has open. Lenders like to see a diverse credit portfolio, including auto loans, credit cards, mortgages and credit cards. Also known as “credit mix,” this factor indicates that a borrower can handle different kinds of credit and, statistically, these types of borrowers are less risky.

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