5 Factors That Can Lower Your Credit Score
1. What is a credit score?
A credit score is a three-digit number that represents your creditworthiness. It is based on information from your credit reports and is used by lenders to determine whether to approve a loan or credit card application and what interest rate to charge. The higher your credit score, the better it is for you because it indicates that you are a reliable borrower who is less likely to default on loans.
2. How is a credit score calculated?
Your credit score is a three-digit number that lenders use to determine your creditworthiness. It’s based on several factors, including your payment history, credit utilization, length of credit history, types of credit in use, and new credit. Here are some key elements of how your credit score is calculated:
Payment history: This accounts for 35% of your credit score. Lenders want to know if you pay your bills on time. Late payments or collections can have a negative impact on your score.
Credit utilization: This is the amount of credit you’re using compared to your credit limit. It accounts for 30% of your credit score. Ideally, you should keep your credit card balances below 30% of their limits.
Length of credit history: This factor accounts for 15% of your credit score. The longer your credit history, the better.
Types of credit in use: This accounts for 10% of your credit score. Having a mix of different types of credit (e.g., credit cards, loans, mortgages) shows responsibility with debt.
New credit: This accounts for 10% of your credit score. Too much new credit can signal risk, so it’s best to space out new credit applications.
3. Negative items on your credit report
Negative items on your credit report can have a significant impact on your credit score. These items include late payments, collections, charge-offs, and bankruptcies. Late payments are the most common negative item on a credit report and can lower your credit score by as much as 100 points. Collections and charge-offs are also negative items that can lower your credit score, although they may not have as great of an impact as late payments. Bankruptcies are the most severe negative item on a credit report and can result in a lower credit score for several years. It’s important to keep in mind that negative items on your credit report can stay on your report for different lengths of time depending on the type of negative item. For example, late payments typically stay on your report for 7 years, while bankruptcies can remain on your report for up to 10 years.
4. Payment history
Payment history refers to the timely payment of bills and debts, including credit cards, loans, and utility bills. It is one of the most important factors in determining your credit score. If you have a history of late payments or defaults, it can negatively impact your credit score. On the other hand, a good payment history can improve your score significantly. To maintain a good payment history, it is important to make all payments on time, every time. This includes credit card payments, loan payments, and any other bills that are due. Even small payments such as utility bills should be paid on time to avoid negative marks on your credit report. It is also important to keep track of all payments made, as this can be used as evidence of a positive payment history if needed.
5. Credit utilization
Credit utilization refers to the amount of credit you are currently using compared to your total credit limit. It is expressed as a percentage and is an important factor in determining your credit score. A high credit utilization rate can negatively impact your score, while a low credit utilization rate can positively impact it. It is recommended to keep your credit utilization rate below 30%.
6. New credit
New credit refers to any new accounts or lines of credit that have been opened by the individual. This can include things like opening a new credit card, taking out a loan, or applying for a mortgage. The type of credit being applied for does not matter, as long as it is new.
When a new account is opened, it will initially show up on the individual’s credit report as a hard inquiry. Hard inquiries can negatively impact the individual’s credit score because they indicate to lenders that the individual is seeking new credit. However, after a certain period of time (usually around one year), these hard inquiries will no longer affect the individual’s credit score.
It’s important to note that the number of new accounts opened can also impact the individual’s credit score. Having too many new accounts can indicate to lenders that the individual may be struggling financially and is therefore a higher risk. On the other hand, having a few new accounts can show that the individual is looking to build their credit history.
Overall, new credit can have both positive and negative effects on an individual’s credit score. It’s important to carefully consider the potential consequences before applying for any new credit.
When it comes to maintaining a good credit score, one factor that can have a significant impact is the number of inquiries on your credit report. An inquiry occurs when a lender or creditor checks your credit history to evaluate your creditworthiness. While having multiple inquiries may seem like a red flag, there are some situations where they are perfectly acceptable. For example, if you’re shopping around for the best mortgage rate, it’s common to receive multiple inquiries from different lenders. However, if you’re applying for too many credit cards within a short period, it could negatively affect your credit score. The key is to keep a close eye on your credit report and only allow authorized inquiries. This means that you should review your credit report regularly and remove any unauthorized inquiries. By doing so, you can avoid any negative impact on your credit score.
8. Length of credit history
Length of credit history refers to how long a person has had credit accounts open. It is one of the longest-lasting negative factors that can affect a credit score. The longer the length of credit history, the better it is for a person’s credit score. This is because it shows that the person has been managing credit responsibly over a long period of time. However, if a person closes their credit accounts, this can negatively impact their credit score. It is important to keep credit accounts open and active to maintain a good credit score.
9. Types of credit in use
Types of credit can greatly impact your credit score. There are two main types of credit: revolving credit and installment credit. Revolving credit allows you to borrow money and pay it back over time, while interest accrues. Examples include credit cards and home equity lines of credit. Installment credit involves borrowing a fixed amount of money and making regular payments until the loan is paid off. Examples include car loans and personal loans. It is important to keep track of how much credit you have in each category as too much revolving debt or too many installment loans can negatively affect your credit score.
In conclusion, it is important to understand how your credit score is calculated and what factors can negatively impact it. By being aware of these factors, you can take steps to improve your credit score and avoid any negative consequences. Remember to always pay your bills on time, keep your credit utilization low, and avoid applying for too much new credit. With responsible financial habits, you can achieve a good credit score and enjoy the benefits that come with it.