Having a good credit score is an important element of your financial well-being. Your credit score is used by lenders to determine whether you will qualify for credit and, if you do qualify for credit, the amount of interest the lender will charge for that credit. However, your credit score is used for more than just obtaining credit. A low credit score may result in higher insurance rates, more difficulty qualifying for a cell phone plan, and more difficulty getting the apartment you want.
How are Credit Scores Calculated?
Credit scores are based on your financial history. The credit reporting agency reviews your financial history as reported by your creditors and uses the information from your credit report to calculate your credit score. Some financial information remains on your credit report for up to 10 years; however, as time goes by, the damage caused by negative items begins to fade. Five major categories are used to calculate your credit score.
Payment History – Your payment history accounts for 35% of your credit rating. Late payments will drive down a credit score very quickly. Bankruptcies, collections, lawsuits, liens, foreclosures, and judgments are also included in your payment history.
Amounts Owed – This factor accounts for 30% of your credit score because owing more money is viewed by lenders as a high risk for new credit. Information such as the balance on all accounts, how many open accounts have a balance, whether some types of debts have a balance, and the total amount of the credit line being used on revolving accounts are used to calculate the score in this category.
Length of Credit History – While this category only represents 15% of your total credit score, it is still an important element. Lenders prefer to see a long history of established credit. Therefore, your score in this category is determined by the ages of your oldest and newest accounts, the average age of all of your accounts, and the length of time since you used certain types of accounts.
Types of Credit – The various types of credit you use accounts for 10% of your credit score. Having a mix of installment accounts, credit card accounts, mortgage loans, finance companies, and other types of credit accounts increases the score in this category. Having only one or two types of debt lowers the score in this category.
New Credit – This category looks at the number and types of new credit accounts you have applied for recently and accounts for the final 10% of your credit score. It may be tempting to apply for a new credit card to get an immediate discount knowing you can pay off the balance and close the account next month; however, doing this frequently will lower the score in this category.
Bankruptcy Can Help Improve a Credit Score Faster
By the time that most people make the decision to file bankruptcy, their credit score has been severely damaged due to negative marks on their credit report such as late payments, collections, high balances, and lawsuits. While the bankruptcy filing will remain on your credit report for 7 to 10 years, often most debtors experience an increase in their credit score within one to two years following their bankruptcy filing.
Debt to Income Ratio