How Credit Scores are Calculated

Have you ever wondered what your credit scores really mean, or how they are calculated? Your credit scores are numerical summaries that are derived from the information displayed in your credit report. There are three different major credit reporting bureaus, and each offers its own credit score based on the information contained in your credit report. The formula that creates the credit score for your credit report takes a number of different factors into consideration, including:

- Your repayment history
- Your credit performance
- Your debt level
- What types of credit you use
- The length of credit history that you have
- New credit you are applying for within the past 12 months
- Accounts that are currently paid as agreed
- Past due payments

What does your credit score mean?

Each credit bureau has its own credit score based on a proprietary formula. Lenders can look at any of these credit scores when trying to determine whether or not you are a suitable receiver of one of their loans. This will give them a good working idea about your history with repaying money, and will also allow them to figure out whether you are a risky borrower or a borrower that is likely to pay your debt off on time.

The way that banks and lenders generally see it, the lower your scores are, the higher your risk factor is. A low credit score is going to essentially tell potential lenders that you have a history of not paying money back to other creditors, or at least not paying the money back on time or as agreed. If you are considered to be a high risk borrower, then lenders may opt for a rate for risk approach, which gives you the lending that you need but at a much higher rate than a lower risk borrower would receive. If your bank thinks you are a high risk borrower, then you are probably going to receive a higher interest rate as a result.

What Factors Affect Credit Score?

Clearly your credit score is affected by paying late on your bills. There are other things that affect your credit score as well, including delinquent accounts, payments that are more than 30 days late, accounts that were turned over to a creditor or collection agency, and bankruptcies are some examples of things that can negatively affect your credit score. Your score can also be affected by hard credit applications, which means the more times you apply for credit, the more negative effect it will have on your credit score overall.

Improving your credit score and report is all about taking small steps and making small improvements over a period of time. The length that you have credit for is just as important as the credit that you have, so take your time in paying things off, and don’t put yourself in worse debt in the process and you should be fine.

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