Finance

How Credit is Calculated and How to Improve Credit

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One of the most important measures of your creditworthiness is your credit scores. A credit score is a three-digit number that ranges between 300 and 850. The higher your credit, the lower your risk to lenders while the lower your credit, the higher your risk to lenders. Understanding how the credit score is calculated and what impacts it will take you a step closer to improving your credit.

The five factors of credit

The credit score comprises of five factors and the calculation is based on these five factors.

The payment history

This accounts for 35% of your credit score. It shows if your payments are made on time, it also shows how often you miss payments, how many days after due you pay your bills and how you have missed recent payments.

The higher the proportion of on-time to the total payments that have been made, the higher your score. While the more you miss payments, the more your credit score is impacted negatively.

The payment history: This accounts for 35% of your credit score. It shows if your payments are made on time, it also shows how often you miss payments, how many days after due you pay your bills and how you have missed recent payments.

The higher the proportion of on-time to the total payments that have been made, the higher your score. While the more you miss payments, the more your credit score is impacted negatively.

5 factors of Credit

Amounts owed

The amounts you owe on credit cards and loans make up 30% of your total credit score. This is derived from the amount you owe, the types and number of accounts you have, the ratio of money owed compared to the cost of credit you have available.

The higher the balance and the more maxed out credit cards you have, the lower your score. While smaller balance can help raise your credit score as long as you pay on time.

Your credit score may drop down (temporarily) if you obtain a little loan with little payment history but loans that are closer to pay off date can increase credit score.

The length of credit history

This accounts for 15% of your credit score. The longer history you have for timely payments, the higher your score. Sometimes, you may feel shying away from carrying debt or applying for credit is the best but it can actually be detrimental to your credit score because you will have no credit history to be reviewed.

Type of credit used

 This accounts for 10% of the score. It is always advisable to have a mix of accounts which include but are not limited to home loans, installment loans, retail and credit cards. Having a mix of accounts may help improve your score.

New credit

 This accounts for the final 10% of the credit score. Opening or applying for new accounts poses a great risk of financial trouble and can lower your credit score. However, if you have had pending loans or credit cards over a long period of time (and is paid promptly), your credit score will increase over time.

How to improve your credit score

Do you want to improve your credit score? If your answer is yes, then you need to follow the steps to take your credit scores to the next level. And yes! 850 score is achievable.

Watch the credit card balance

The smaller the percentage of your credit, the higher your credit rating. Pay down your balance and keep them low to boost your score. For example if you have 10,000 dollar credit line, try to keep it about $8,000 dollars full. If you are having trouble with spending habits, try  the envelope budgeting system.

Eliminate multiple credit card balances

Eliminating nuisance balances is one of the ways to improve credit score. Don’t pollute your credit report with a lot of balance. Pick your favorite card, perhaps the one with rewards and use it often. This way, you will remember which one to pay. Also, you don’t need to have 10 credit cards to build your credit. One or two solid ones are good enough.

Related Article: What collection agencies won’t tell you

Remove collection records from your credit report

If you already have bad credit due to delinquencies and collection, you can try to remove it. This requires a little bit of work but it is worth it. Call the collection companies and the company you owed money. Try to make a deal with them like, payment in exchange for removing you the negative report on your credit report.

To get started, apply for a copy of your credit report to see where you can make these changes.

Make use of your calendar

It’s always advisable to do shopping (student’s loan, car or home) within a short period of time.  This is because your credit score dips every time you apply for credit.

Auto pay your bills

If there is one important thing to do to improve your credit scores, it is to pay your bills on time. Laziness and procrastination are the main reasons why many people miss their due date.  However, I understand that we are humans and prone to mistakes. Try auto pay. This is what I do to avoid late payments. I have a post on the richest man in Babylon which touched on crushing the spirit of procrastination within you.

Other ways to improve credit score include:

  •  Keep an eye on any negative mark that might want to affect your score.
  •  Don’t go beyond your credit limit; Set up an email alert to keep you posted when you are getting closer to your limit.
  • Tackle past bills to get better scores; you can help yourself by signing up for reminders if you are prone to forgetting.

I firmly believe that, with proper discipline, anyones credit can be optimized. This will save you a lot of money in the long run. By qualifying for lower rates when you make a purchase, your savings could add up too.

Dr. Breathe Easy’s Bio

 I am a 32 year old practicing pulmonary critical care physician with love for financial concept. This love has turned into blogging. I figured, if my day job helps people breathe easy, why not apply to it finances. That is why I am teaching people how to breathe easy financially. My aim is to improve financial literacy especially among doctors. I cater to those considered the babies of personal finance with a little sprinkling of toddler concepts. My mantra is spend less, save more, earn more and invest.

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