Everyone has heard the term "credit score". It's the three-digit number determined by your credit history. It tells a lender how well you've managed past credit and predicts your future creditworthiness. Your credit score can affect your ability to purchase a home, get a new car, or in some cases, secure a job. But do you really understand how credit works or the different factors that affect your score? Here is some insight on things you might not know when it comes to your credit:
That "FREE" credit score may not be your FICO score. There are several free tools that can give you some idea of what your credit score may be. Companies like Credit Karma offer an alternative score called a VantageScore, which is usually free with a subscription to their finance services. But according to the Consumer Financial Protection Bureau, this alternative or "educational" score is not the same as a FICO score. In fact, it is not typically used by lenders to make credit decisions. There are actually 65 models of credit scoring that financial institutions can choose from with respect to lending. So when you request your score from a free service, remember that it can be several points higher or lower than the FICO credit score pulled by a lender.
You need to understand credit utilization. Credit utilization is the ratio of your credit card balances to credit limits. To calculate credit utilization, divide your credit card balance by your credit card limit and multiply by 100. For example, if you have a $25,000 credit card limit and your balance is $1,000, the utilization on that card is 4%. The lower the utilization, the better; this means you're only using a small amount of the credit that has been loaned to you. High credit utilization can be damaging to your score because it indicates that you may be overextended or at risk of falling behind on payments. A good rule of thumb is to keep your credit utilization at 30% or lower to maintain a healthy score.
Know what affects your credit score, and what doesn't. Your score is calculated based on five major factors: payment history (35%), credit utilization (30%), length of credit history (15%), new credit (10%), and credit mix (10%). This means that missed payments, maxed out credit cards, and multiple new credit accounts opened in a short timespan can be big trouble for your score. There are also some things that don't affect your score at all. For example, pulling your own credit report is considered a "soft inquiry" and has zero impact on your score. Utilities, cellular bills, cable, bank accounts and medical bills are not reported to the credit bureaus and therefore, have no direct affect on your score. That is, unless they become delinquent and are reported to collections.
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