How Does the Credit System Work?

Understanding the credit system isn’t as hard as it seems. Consider credit scoring as a protection system for both the lenders and you as an individual. To give you access to a specific line of credit, lenders need to check your credit score and figure out how likely you are to pay that credit back. Business loans, student loans, a new credit card; all of this affects FICO scores. To understand the whole system, we need to start with the credit score basics.

How is the score generated?

FICO scores are calculated by using many different factors. This data is made up out of five main categories.

  • Payment History (35%) 
  • Amounts Owed (30%)
  • Length of Credit History (15%)
  • New Credit (10%)
  • Credit Mix (10%)

Your payment history provides insight into your personal finance and how well you manage your money. You can consider it as a report of your ability to make payments on time. If you aren’t paying your bills regularly or are late with your credit card payments, your credit score will be negatively affected.

The amounts owed depends on your utilization ratio. If you are using more than 30% of your available credit, the chances of lenders rejecting you are increased since your credit score is lowered. Overuse of your available credit can be an indicator that you are overextending, so lenders may consider that you are at a higher risk of default.

The length of your credit history lowers or increases your FICO score depending on your overall credit track record. People who have long history records typically score higher than those with shorter records. However, there are some cases when people who haven’t been using credit for that long have higher scores; this depends on the rest of their credit file.

New credit indicates how many new accounts you have opened. Credit shopping requires credit inquiries that remain on your credit report for two years. It is important to know that FICO scores only consider inquiries from the last 12 months.

Credit mix looks into a combination of credit cards, retail accounts, installment loans, finance company accounts, and mortgage loans. You don’t need to have one of each, but if you do, they will influence your overall score.

The difference between a good and bad credit score

FICO credit scores range from 300 to 850. On this scale, having a score of 700 and above is generally considered a good score. A score that is 800 and above is an excellent credit score, while a fair score ranges from 630 to 699, and anything below 600 is viewed as bad. These estimates may vary depending on the source of information, but these can be considered as average ranges for FICO scores.

Consumer Affinity’s Split® Credit Monitoring solution checks your score monthly, plots it as you progress through the month and provides you with both a color-coded band and an easy to understand descriptor. We try to make it as easy as possible for you to understand how creditors might view your score.

Importance of credit categories isn’t the same for everyone

Depending on your overall record, your credit utilization might not be as important as on-time payments. For example, different calculations are used for those who have never used credit before. Since your score is unique, whenever it changes, the importance of your categories may change as well. Because of these frequent changes in your score, you can’t precisely know which factor has the most impact on your score without knowing the details of your whole file.

Credit monitoring can be a helpful tool in these situations. 

If you want to keep a close eye on your credit scores, you can do so by using services like Split®. With Split®, email notifications are sent as soon as your score changes. Not only will this keep you updated, but it will also provide protection from identity theft, which has become a growing problem across the United States. According to reports, cyberattacks are the fastest growing crime in the U.S. with almost endless possibilities for the perpetrators. With a stolen identity, they can open new credit cards under your name and cause a disastrous impact on your credit score.

Understanding your VantageScore

The VantageScore was developed by the three major credit bureaus, including Experian, Equifax, and TransUnion. Their latest 3.0 model also includes a range from 300 to 850.

VantageScore Ranges

  • 300-499 – Very Poor
  • 500-600 – Poor
  • 601-660 – Fair
  • 661-780 – Good
  • 781-850 – Excellent

Just like your FICO score, the VantageScore system uses different determination factors.

  • Payment history – most influence
  • Age of credit account and type of credit– strong influence
  • Total balances and debt – moderate influence
  • Recent credit behavior and inquiries, available credit – low influence

While they are different scoring models, they serve as providers of valuable information to both the lender and you.

Not everything is considered in credit scores

Paying your bills on time can result in good credit reports, but there are some factors that aren’t taken into consideration at all. Some of them are a part of The Equal Credit Opportunity Act (ECOA) that prohibits discrimination in any aspect of a credit transaction.

  • Race or color
  • Religion
  • National origin
  • Sex
  • Marital status
  • Age

Others include your salary, occupation, title, employer, date employed, or employment history but also where you live. Soft inquiries are also excluded from your credit score. These occur when you check your credit score or when companies are making promotional offers of credit.

Common facts regarding credit scores

  • Credit reports do not include credit scores, and your scores are not kept as part of your credit history.
  • Individuals who cannot qualify for a loan can utilize joint accounts. In this case, all account holders are responsible for paying the debt.
  • Marriage doesn’t merge your credit scores with your spouse’s.
  • Checking your own credit doesn’t hurt your credit score. As mentioned above, this is considered a soft inquiry and is not used in the calculation process.

How to improve your credit scores

Based on the information you have gathered from this article, it should be easy to recognize what actions can help you improve your credit scores. Manage your monthly payments and utilize Split® Credit Monitoring to check and improve your credit. Keeping an eye on the changes can help you understand what you are doing wrong and how much of an influence it has on your credit scores.

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