Applying for a loan, whether it be a personal, home, or vehicle loan, involves several factors, not the least of which is your credit score. But it’s important to know how your credit score works to understand your ability to secure a loan. Basically, your credit score is a number used by financial institutions to evaluate the likelihood that you’ll pay back your debt. The higher your score, the higher your creditworthiness.
It’s important to note that your credit score is different from your credit report. Your credit report is actually the raw data, while your score is what a Credit Report Agency makes of that data using various scoring models. The three main credit reporting agencies, Experian, Equifax, and TransUnion, each maintain a separate credit report on you. Your credit score is based on a report from one of these three agencies.
When you apply for credit, whether it’s for a mortgage, auto loan, or credit card, lenders want to know what kind of risk they will take by lending you money. A good score can save you an incredible amount of money over your lifetime because of lower interest rates.
Factors Which Influence Your Credit Score
1. Percent of on-time payments
Part of your score is influenced by how often you make your payments on time. It’s a significant factor in calculating the score, so even one or two late payments can have a negative impact.
2. Open Credit Card Utilization
Open credit card utilization is your available credit compared to how much you use. This ratio is calculated by the balance you have at the time your credit card issuer reports to the credit bureau, not the balance you carry over from month to month.
3. Derogatory Marks Items
These items include bankruptcies, foreclosures, collections and liens, and will have a negative impact on your credit score. These items can take from seven to 10 years to clear from your credit history. It’s an indication to the lender that you’ve mismanaged credit in the past.
4. Average Age of Open Credit Lines
If your credit history is lengthy, lenders have more information by which to accurately assess your creditworthiness. The older the average age of your open credit cards, auto loans, mortgages, etc., the more it indicates that you’ve been able to manage credit over a long period of time.
5. Number of Accounts
Consumers with a higher number of credit accounts open typically have better scores because they’ve been approved for credit by more lenders than those with a smaller number of accounts open. Also, having various type of credit on your report can be a positive indicator.
6. Number of Hard Credit Inquiries
A hard inquiry is how often a financial institution checks your credit while deciding to approve you for a loan or credit card. Multiple hard inquiries can have a negative impact on your score because it can suggest that you’re desperate to apply for credit or are unable to qualify for credit. That’s why it’s a good idea to not apply for several lines of credit at once.