It is not a secret that the credit score system is taking a lot of heat recently. The credit scores in existence today are far from perfect and what’s even worse is that most consumers don’t even know where to go for help in fixing the wrong ones. Luckily, the credit repair market has seen unprecedented growth since the time people first started noticing that their credit scores were in bad shape. Despite the fact that the economy is improving slowly, it is clear that millions of consumers aren’t benefiting from the recovery yet. Most of them might not realize that a good credit score can be an asset that can turn an entire family from financial misery to one of the luckiest people on the planet. Take a look at Factors that Affect Your Credit Score.
What Is a Good Credit Score?
Before we dive into the main topic of this article, I’d like to address the misconception that a credit score represents a measure of your creditworthiness. As most people know, a credit score is a composite statistic that accounts for two main factors:
- Transactional history (the average number of times you pay a bill on time over a rolling, three-month period). This is the most important factor and it accounts for 40% of the score.
- Credit utilization ratio, i.e., the ratio of your overall debt to your available credit. This is the second most important factor and it accounts for 35% of the score.
Now, a good credit score is not the same thing as having a perfect credit history. That’s because your credit history only accounts for about 30% of the overall score, while the other 60% is mainly determined by how you behave over the past 3-6 months and how you perform in comparison with other people in the same situation. The main goal of a good credit score is not to tell you that you are a creditworthy person with a very low probability of being late with a payment. Instead, a good credit score will tell you whether you can start saving on your credit card bill if you’ll be able to buy a car next year, if you’ll be able to rent an apartment for the first time and whether you are on the verge of bankruptcy.
Top 12 Factors That Can Affect Your Credit Score
For the purposes of this article, let’s take a closer look at the top 12 factors that can affect your credit score:
1. The Default Rate (Defaults)
The default rate is a measure of how often consumers who are seeking to get a loan don’t pay it back. Some lenders don’t report your payment history to the credit bureaus so your debt actually reflects what they call “negative amortization” – your payments are actually larger than your total debt. This is the most common type of credit score decline, which means that your credit score will drop significantly if you have more than one default. Some lenders, like Experian, are working on a solution. These lenders are tracking customer payment behavior in real-time and providing lenders with valuable credit information that helps them identify customers who are in default so they can work out a plan to help them avoid default. However, this solution is not widely available yet.
2. Collection Trends
Not only do the major credit bureaus calculate collection trends scores but they also display them at the bottom of the consumer credit information page on their website. What this score actually means is that the percentage of the time you are contacted by a creditor to collect debts has increased over a given period. The higher the percentage, the worse your collection efforts are. Achieving a perfect collection score requires consistent debt repayment over time and the ability to reach an agreement with a creditor to reduce or avoid additional debt.
3. Credit Card Activity
Credit card activity is actually two different things. One part includes the frequency and volume of your credit card use, i.e., the number of credit card transactions you carry out on your credit cards during a rolling 30-day period. The second part is a measure of how many of these transactions have been paid off on time during the rolling 30-day period. If you have a credit card with an annual interest rate of 14% that has been used over 500 times during a 30-day period, for example, you can see that you made no payments during that period (debit activity included).
This is how you can improve your credit card activity score:
You can make the minimum payment on time in order to get your credit card debt collection score back up, even if it’s still slightly negative. You can stop using your credit card for unnecessary spending and dedicate a certain part of your monthly budget to paying off your credit card debt. This will help you avoid defaulting on your payments and get your credit card debt collector calls down to zero.
4. Credit-Driven Advertising
There are several types of advertising on the Internet. Some of them are sponsor links. These are the ones which tell you about various products and services. If you click on those links, your credit score can go down. When you sign up for those links, you often have to give out personal and credit card information, which can also affect your credit score negatively. Credit cards offer the opportunity to significantly increase your credit score by only paying the minimum monthly payment.
5. New Applications
When you apply for a new credit card, you will evaluate by the credit bureaus to determine your creditworthiness. As soon as you submit a new application, you will move from a score of 680 to a score of 700. Although the impact on your credit score is very small, the more applications you submit the faster your score will drop. This means that you have to apply for new credit card accounts more frequently to keep your score healthy. Making payments on time is the best way to avoid a credit score drop.
6. Delinquency Rates
A large number of people in the U.S. have some sort of delinquency on their credit reports. Delinquency rates are expressed in terms of months past due. A three-month delinquent debt would be equal to the following:
- 62 months of 6.75% interest, for a total of $15,430
- 37 months of 6.50% interest, for a total of $15,340
- 18 months of 6.00% interest, for a total of $11,580
- 10 months of 5.00% interest, for a total of $10,880
Three-month delinquency is also called a 606. A delinquent payment is never a negative mark on your credit report; it’s always taken off in exchange for a lower interest rate, balance transfer, or a payment plan. It’s important to know, however, that people who have lower credit scores can still get an unfair interest rate on their debt.
7. New Credit Transactions
Credit-card companies like to see that you are opening new accounts for credit card use and that you are actively using these new accounts. In order to maintain a positive credit score, make sure to repay the balance on each new credit card transaction, even if the payment is late. When you open a new account with a new lender, or you apply for a credit card, you are increasing your credit utilization. This increases your credit score, but it also increases the risk that you won’t be able to pay your new debts back on time.
8. Automated Approvals
When you apply for a credit card, you are also getting an automated approval, which is a second credit score. The payment history information from your past credit card activity is used as a score. This score will be extremely important when it comes time to look for a home loan, car loan, or second mortgage. An automated credit score can cause your credit score to drop over time if you don’t pay off your debts on time.
9. New Accounts with the Same Credit Card Company
When you transfer your credit card debt to a different credit card company, you have just increased your credit card utilization. A credit card with a high credit limit and low credit utilization are likely to increase your credit score as long as you pay off your debt on time. However, having multiple credit cards with the same credit card company can be a sign of poor financial management.
10. Late Payments
On average, someone who pays their credit card bill on time pays about 13% less than someone who pays late. Every one dollar in late payments lowers your credit score by about 2.5 points. If you default on one of your credit cards or if you have several late payments in a row, the credit bureaus will report these mistakes to the credit bureaus and the lenders.
11. History of Receiving Borrower Payment
The more delinquent accounts you have, the more difficult it is to build up a good credit score. A good example is a borrower who has a history of late payments from years ago. This history will report as a poor history of paying back creditors, which will bring down your credit score. There are several other things that can impact your credit score besides your debt history and payment history.
Your credit score is also impacted by the following:
- The length of your credit history, or how long it has been since you opened a new credit card or had a credit card in collections.
- Your credit score is influenced by how long you’ve been a customer with the lender that is reporting your credit score. Lenders use the years since your last credit card to decide whether to increase your credit limit or give you a lower interest rate. Lenders don’t want to give you a credit limit they think you can’t pay back on time.
- Your credit score is also affected by the fact that you have other debts. If you have a mortgage or are paying off several high-interest credit cards, your credit score is going to be lower. The interest rates on your credit cards will also impact your score. It doesn’t matter whether you pay them off every month or if they are still on your credit report. Your payment history will also be reported.
12. Credit Cards with High-Interest Rates
If you are a young adult, it’s important that you do not get a credit card that has a higher interest rate than other credit cards. This can have a negative impact on your credit score, even if you pay off your balances in full each month. The longer you carry a high-interest rate balance, the more your debt will compound and the harder it will be to pay off your debt. It will affect your credit score badly.
Wrapping – Up!
There are various factors that affect your credit score and all these factors must check regularly. You can easily check your credit score on sites such as Credit Karma and Experian. If your credit score is below a certain level, there are several things that you can do to help your credit score. If you’re in debt and your credit score is below a certain level, you need to make some important changes to your spending and budgeting habits. And how long it takes to build up a good credit score will vary from person to person.
The key is to pay off your debts each month and not to carry a high balance in any credit card account. With your age, the goal is to get to about a 700 credit score. If you have multiple credit cards, you can close them, but not all. Doing so will not help your score and the fewer cards you have, the higher your credit score will be. So, make sure you stay on top of your credit score and be mindful of any positive changes or negative changes!