Learn How Debt Affects Your Credit Score (FICO)
Your Credit Score and Rating
Whenever you apply for a line of credit – whether it be a mortgage, a personal loan, or a credit card – your credit rating is the deciding factor in if you receive the credit, and what your interest rate will be. Most of the people realize this, however, they don’t understand how their credit score is tabulated and what their debt and financial history has to do with the three numbers associated with their credit worthiness.
There are many credit bureaus in the United States, but most people are familiar with the big three: Equifax, Experian, and TransUnion. Each of these use FICO (a credit scoring system devised by Fair Isaac & Co.) to establish that three digit number, which goes from a low of 300 to a high of 850.
Let’s breakdown the equation used in determining this number:
- One-third of the score is based on your payment history. Any late payments, skipped payments, and defaults will affect this portion of your score in a negative fashion. If you’re a stickler about paying on time for at least the minimum amount, then you have nothing to worry about.
Another one-third is determined by how much debt you have as compared to what available credit you have, as well as what your total current debt is. So, if you tend to max out your personal lines of credit, this portion of your score will be affected negatively. Alternately, if you only hold a few lines of credit and tend to pay most, or all, of your balances off monthly – the effect will be positive.
- The final one-third is a tabulation of three different factors. How long of a credit history you show; the amount of recent credit you’ve applied for; and what types of credit are in your history. Of these three, the length of your credit history has the heaviest weight.
Those who have already established a long history of borrowing and repaying what they owe are looked on as a more favorable credit risk. Secondary to your credit history length is how many recent applications for credit you have. The higher the number, the lower the score. Lastly, the types of loans you’ve carried will show your overall spending practices and your consistency in repaying those loans.
Once your score is reached and given to prospective lenders, it is the primary; and in some cases, the only, factor that is used in deciding what interest rate to charge you. Therefore, the higher your score, the less money you will spend overall in any loan you receive. Interest rates can increase the base amount borrowed by a somewhat insignificant number up to a very significant number that is translated into dollars out of your bank account.
Also, credit reporting agencies are not always accurate. You should definitely acquire a copy of your credit report to search for inconsistencies and untruths. If you find any, you can dispute them with the reporting agency.
To save the most money you can whenever applying for any type of a loan; be sure you have the knowledge on how your credit worthiness is scored and that the information they have is absolutely correct.
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