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Understanding Your Credit Score

Posted on May 15, 2015

When it comes to finances, borrowing and lending, the magic number people look to is the credit score. A credit score is a number assigned to an individual or business to represent how creditworthy the assignee is. While most people know what a credit score is, they might not be sure of how it works or what they can do to damage or improve it. Credit scores become essential when trying to make large-scale purchases, such as a new house or a car, and having a damaged credit score can be a huge setback. Here's the lowdown on how that mysterious credit score is determined and how you can go about fixing one that's been damaged.

How Credit Scores Work
Most people actually have multiple credit scores because individual lending institutions can come up with their own formulas for creating them, but the most commonly used one is the FICO score. The FICO credit scores are based on a scale ranging from the lowest possible credit score of 300 to the very best at 850. Generally a score of 720 or higher is considered a good score, though lenders may have their own standards that determine what they let the person borrow and at what interest rates. There are five factors that make up your credit score, each with their own percentage of how much weight they carry. Here's what the breakdown looks like: your payment history (35%), the amount owed (30%), the length of your credit history (15%), evidence of your interest in obtaining more credit (10%), and the ratio of credit to debt (10%).

Even with a finite list of factors, depending on with which bureaus a lender contacts, the score can come out different because not all the information will necessarily be taken into account. Anyone who sees a blow to their credit score should be ruthless in their scrutiny of their credit reports, as many reports come back with errors. Just one more entry on the long list of reasons to keep your financial documents in order!

What Damages a Credit Score
Damage to a credit score occurs when a person or business has problems within those categories that are used to calculate the score. The culprit for a drop in your credit score could be any of a number of things, and the laundry list of what hurts people's credit scores can get quite long. Since payment history makes up a full 35 percent of the score, things like making late payments or not paying at all are some of the worst things that someone can do to damage their score. Other credit-damaging areas include, but are not limited to, defaulting on a loan, having high credit card balances or maxing out credit cards, filing for bankruptcy, and applying for several credit cards in a short period of time.

Improving Your Credit Score
It takes time to improve credit scores, and you will only really see significant changes in the long run. Some big tips to keep credit scores healthy include paying bills on time, keeping credit card balances low, only applying for new cards when necessary, and paying off debt rather than moving it from one card to another. Paying off loans and reducing debt in general will improve credit scores in the long term, though it's never a guarantee.

Improving a score quickly isn't necessarily impossible, though it's more a matter of manipulating the five factors that make up your score than real improvements to your financial situation or creditworthiness. To improve the credit utilization ratio (what percentage of available credit is being used), you can try to acquire a new card or ask for a higher credit limit, don't cancel any cards, or use a different card. Paying bills and paying off as much debt as possible are also good ideas to keep your score healthy.

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