Written by: Josh McFadden | Best Company Editorial Team
Last Updated: October 30th, 2019
There are a number of instances when your credit score will come into play. Depending on your personal situation, this scenario might be the cause of nervousness and anxiety.
Perhaps you have decided it's time to purchase a new home or a recreational vehicle. Maybe you need an upgrade from your current automobile to something more reliable and suitable for your needs. It could be time to go back to school, but since there's no way you can cope with rising tuition costs, you need to apply for a student loan.
Credit checks don't even have to be done on large purchases and financing necessities. Many people take out a line of credit to buy new furniture, jewelry, appliances, or even a credit card at a supermarket or other retailer.
Some employers even conduct a credit check as part of a background check.
Regardless of the reason, your credit score will determine your qualifying amount as well as the rate and terms associated with your loan. It will even determine whether you get the loan at all.
As a numeric expression of your history in dealing with credit and loans, it's important to know just what a credit score entails. Here are the basic components of a credit score and how much weight each element generally carries.
The most common type of credit score is the FICO score. Measured between 300 and 850, it is taken into account when purchasing homes, cars and credit cards. About 35 percent of this score is made up of one's payment history. Essentially, a lender will closely examine whether a person has negative or derogatory information on his or her report. This means if there are bankruptcies, settlements, liens, judgments, repossessions, charge-offs, foreclosures or late payments, the payment history portion of the score will take a hit.
FICO takes into consideration a number of different metrics in this category, often relating to credit card debt. Some of these are the following: debt to limit ratio, the number of accounts with balances, the amount owed across different account types, and amount the payee has paid down on any installment loans. A person possessing several credit cards, multiple car loans, retail credit cards, second mortgages and the like, will have a lower score than someone with few of these types of debt, especially if most or all have balances. Importantly, credit scores will be higher if the person's credit card balance is low compared with the limit. This component of the score accounts for about 30 percent of the total score.
Length of credit history
The longer a person's credit file has been open, the better it is for his or her score. Younger people just starting out in the work world, for example, often have lower scores, as they haven't had time to build up credit through various sources. The average age of credit accounts and the age of the oldest account are considered for this portion of the score. This category makes up about 15 percent of the credit score.
Types of credit used
As explained, one might have debt in the form of installments, revolving credit, consumer finance, mortgages and others. While an excess of credit types can be harmful, a strong diversity can work to one's advantage, especially if one can demonstrate an ability to manage all accounts. This accounts for 10 percent of the total score.
Recent credit searches
Whenever one applies for a credit card or a loan, the prospective lender will perform a hard credit search. Each time this happens, the score is lowered. If the consumer pulls the credit, it will have no such effect. This category makes up 10 percent of the total credit score.
As you make credit decisions, be aware of these different factors and how they affect your ever-important credit score. These could be the difference between obtaining the loan you seek and need and being embarrassingly declined.
Have more personal loan questions? Find answers to your questions with our FAQ page dedicated to Personal Loans.