When you are applying for a loan, the first thing lenders will do is check your credit score – and this will have a strong impact on their ultimate decision. So what is your credit score and how do you maintain a good score that will impress lenders?
The five elements of your credit score
Your credit score is a three digit number designed to indicate how likely you are to meet your credit obligations. Lenders will look at your score to decide whether they are prepared to give you credit for a loan. The score is calculated based on five elements of credit history information – your payment history, your level of debt, your credit age, your mix of credit and enquiries. You could look at your credit score like a school grade, where different subjects have different weighting on your overall mark.
Pay your bills promptly
Payment history makes up 35% of your “grade.” This is based on your ability to pay your bills promptly, and any history of late payments, collections or bankruptcy will have a negative impact on your score, particularly if they are recent. For a good grade in this subject, make sure you maintain a history of paying your bills on time.
Minimize your debt
Debt level makes up 30% of your score. Your level of debt is compared to your credit limits to calculate what is called your credit utilization. If your credit utilization is high, then your level of debt is close to your credit limit, making you a bad risk.
In simpler terms, this just means to keep your credit balance low in order to reach a higher credit score. For example, if you have a $1000 credit limit on your credit card, don’t exceed a debt of $300. If you have numerous lines of credit, try to pay some off or consolidate them, so you are not juggling too many debts.
Don’t close your first credit card account
Your credit history makes up 15% of your score. A longer credit history will result in a higher score, as this provides more information about your ability to manage your finances. So rather than closing your oldest credit card account, keep it open to demonstrate your long term credit history.
Limit your credit applications
Inquiries, which are worth 10%, refer to the number of credit applications you have made in the last year. An excessive number of applications can negatively impact your score as it looks as though you are taking on too much debt or you are desperate to be approved for a loan.
The final 10% is based on your mix of credits, which refers to your ability to successfully manage a mix of credit accounts. However, this is only considered important if there is insufficient information available from the first four categories.
Check your credit score
Even if you are sure you are doing everything right, it is prudent to check your credit score before you start applying for loans. You might find a way to improve your credit score and increase your chances of securing the loan you want.
Another good reason for checking your credit score regularly is to ensure that there is no inaccurate information stemming from credit card fraud or identity theft. When you check your score regularly, you can confront issues like this immediately.