Credit scores, even for those that know their number or range, can be confusing to interpret. Luckily, there are a few fundamentals that can help explain the complex credit scoring system.
How Does Credit History Work?
Imagine that someone asks you for a $100 loan. Would you promptly hand over the money without question? Probably not. You’d want to know whether he’s repaid loans in the past and how quickly – this is credit history. When you apply for a loan, the lender will want to know your credit history, too.
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So where does the history come from? Your lenders regularly report to credit bureaus, detailing the status of your credit accounts. There are three major credit bureaus and different lenders that report to different bureaus. The credit bureaus then compile this information into a credit report.
Why Does Credit Matter?
Banks typically won’t make loans to those with poor credit histories, and if they do, they want something in exchange for the risk they’re taking. This means the terms of the loan, specifically the interest rate you’re given, may not be as favorable as they would be for someone with a good to excellent credit history.
According to our study, one in two landlords ask for credit reports, and some auto insurance companies use your credit history to calculate insurance scores that help determine how much you’ll pay in premiums.
How Is Your Score Calculated?
Many lenders may not have the time or inclination to study every detail in your credit report, so the credit bureaus and agencies condense all that information into a three-digit number – your credit score – designed to indicate how at risk you are for defaulting on a loan.
This isn’t to say that a lender won’t also read your entire credit history. It may happen if you’re applying for a very large loan, such as a mortgage, or if your score is marginal between credit ranges, and the lender wants to know the story behind it.
So, what information goes into this numerical value? How timely you are with your payments can weigh heavily on your score, as does how much of your available credit you’ve used. If you have one credit card with a $1,000 credit limit and you’ve maxed it out, you’ve used 100 percent of your available credit. If you’re carrying just a $200 balance, you’ve only used up 20 percent of your available credit and this is considered pretty good. Generally speaking, the lower your credit utilization ratio, the better.
Other factors include the length of your credit history – the longer you’ve been borrowing successfully, the better. They also may consider the different kinds of accounts you’ve been paying on, and any new accounts you’ve applied for recently. Applying for multiple loans can be interpreted negatively.
What Does a Typical Credit Report Include?
Lenders typically report how much you’ve borrowed and whether you’ve ever been late with any payments. If so, how late were you? Sixty or 90 days late is worse than 30 days late, but, of course, you really don’t want to be late at all.
Your credit report includes both open loans and loans you’ve paid off or closed, at least for a period of time. It shows if any accounts have been turned over to debt collectors, even if the debt was one that wouldn’t normally be reported to the credit bureaus, such as a medical bill. That said, not all new risk scores do take medical collections into account. Public records like tax liens, court judgments and bankruptcy filings also appear, and these can drag your score down a great deal.
What Happens to My Credit If I Don’t Pay Off My Credit Card Every Month?
There’s a difference between paying off your card entirely every month and making at least a minimum payment every month. Not missing a payment is critical. Paying off the whole balance is not, although it can favorably affect your credit utilization ratio. You don’t technically get any points for paying off the whole balance in one payment. You get points for not using all or too much of the credit available to you.