What Affects Your Credit Score?

By Angela Monroe - September 4, 2019

When you apply for a loan, the first requirement that potential lenders ask for is your credit score. This three-digit number represents your creditworthiness and influences your borrowing power. It also affects the interest rate and terms of your approved loan. Because it helps lenders assess the risk associated with you as a borrower, it is also called a “risk score”.

The typical credit score range is between the lowest 300 and highest 850. The higher your credit score, the better the chances of acquiring a loan. It reflects better credit decisions, which convince lenders that you will repay your loan on its agreed term.

How to Get Your Credit Score?

Your credit score is provided by the credit reporting bureau, which keeps a record of your debts and payment history. It is calculated based on the information in your credit report using a scoring model that assigns a value percentage to certain factors that estimate the probability of default.

Not all lenders report to the credit bureaus; some only send your credit information to one or two credit reporting bureaus. Your credit score may vary from one agency to another depending on the information they’ve compiled and the credit scoring model they are using. 

FICO Credit Scoring System

Majority of credit reporting agencies follow the credit scoring system set by the Fair Isaac Corporation, a data analytics company. The FICO model assigns all borrowers with a credit score that ranges between 300 and 850. 

The credit score can fall into different score range classifications:

Very Poor – 300 to 579
Fair – 580 to 669
Good – 670 to 739
Very Good – 740-799
Exceptional – 800 to 850

From this subranges, borrowers with good to exceptional credit scores are likely to get approved for a loan. Those with the highest scores will get the best interest rates and terms. 

Meanwhile, you will have 50-50 chances of loan approval if you score around 650 unless other elements are factored in, such as income, collateral and down payment. 

If your credit score is poor, you will be denied a loan unless you apply for bad credit loans.

VantageScore 3.0 Model

Developed by the three major credit bureaus Experian, Equifax, and TransUnion, VantageScore is similar to FICO Score in that it has a score range of 300 to 850. However, it slightly differs in determining which score is bad or good:

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

Other Credit Scoring Models

While Fico Score and VantageScore 3.0 are the most widely used credit scoring models in the world, there are various other scoring models that exist, including:

Equifax – 280 to 850
TransRisk – 300 to 850
VantageScore 1.0 & 2.0 – 501 to 990
PLUS Score – 330 to 830
Experian National Equivalency Score – 360 to 840

Each credit reporting bureau usually develops its own credit scoring model. Some of these credit-scoring models are intended to predict the creditworthiness of a particular borrower for a specific purpose. Because of the variations, large institutions usually buy multiple credit models when needed.

Factors That Affect Your Credit Score

The information that affects a credit score varies depending on the credit scoring models used, but the most common factors include payment history, credit utilisation, length of credit history, credit mix, and inquiries made on your credit profile.

Payment History

This is the most influential factor in determining your capacity for repayment. It includes all records of payment transactions for previous revolving loans like credit cards and instalment loans like mortgages. 

The payment history is the most important factor in credit score calculation, comprising 35 per cent of the total credit score in the FICO Scoring System and 32 per cent in the VantageScore Model. 

The frequency, recency and severity of missed payments for loans and credit cards will all be examined. All missed payments of at least $150 will be listed on the credit report when it’s 60 days overdue. It will also stay on the file for up to 5 years.

Unpaid bills and unsatisfied loan repayments will also appear on the credit report. Defaulted loans will be listed for up to 7 years after the default claim is paid.

Credit Utilisation

Another important factor in determining your creditworthiness is credit utilisation, which is the percentage of the available credit limit that has been used. 

Credit utilisation specifically targets credit card usage. Each credit card has a credit limit or the maximum amount of credit that a card can provide. Ideally, credit utilisation should not exceed 30 per cent of the credit limit. 

High credit utilisation signals that you have little credit self-control and may acquire debts that may accumulate and become unmanageable over time.

Maxing out your credit card limit is worse. It usually means that you use more credit than you can pay off and don’t have much freedom to decide where the money is going, signalling financial trouble. 

According to FICO, borrowers with the best scores have an average credit utilisation ratio of less than 6 per cent.

Length of Credit History

This is the average age of all your debt accounts, specifically the length of time the accounts have been opened and used. Generally, your credit history needs to be seven years to be considered long. Many lenders believe that this length of time is ideal enough to provide a better picture of your long-term financial behaviour.

A long credit history, especially without any major payment issues, suggests that you manage your debts well and you’re likely to practice the same behaviour in the future. 

Some creditors turn down debtors with spotless credit records if they do not meet the seven-year-rule. It is no wonder that many financial experts suggest the use of credit cards when people turn 18 to start building credit history early.

Credit Mix

Having a good mix of revolving and instalment loans positively impacts a credit score. It makes up 10 per cent of the total credit score in FICO. 

Having a variety of debt products, especially if responsibly managed, indicates that you can efficiently handle all sorts of credit, which represents a low risk for lenders.

Borrowers who dutifully make on-time payments on their mortgages but don’t use credit cards have a higher risk than those who also maintain a line of credit. 

New Debts

Applying for and opening new credit can lower the borrowers’ credit utilisation ratio. However, it also negatively affects your credit score because it suggests that you are in financial trouble. 

According to FICO, borrowers who take on a new debt on top of their old one have a bigger tendency to miss loan repayments and become delinquent than those have not opened new accounts. 

Hard Inquiries

When the lender checks in to your credit profile before approving your loan application, it gets recorded as “hard inquiry”, which negatively affects the credit score. The damage it does depends on the length and breadth of your credit history—You would be more affected if you have a short credit history and few accounts than if you have an established credit history and a wide range of credit.

Generally, new debt applications and inquiries cause a loss of up to five points. The records also stay on your credit report for two years. 

Balances

VantageScore considers the total amount of recently reported balances of current and delinquent accounts as an important deciding factor of your creditworthiness.

Low balances suggest that you’re likely to make monthly on-time payments because the debt doesn’t weigh heavily on your shoulders. Thus, it is good practice to pay off loan balances monthly.

Trended Credit Data

VantageScore Solutions’ fourth-generation scoring model called VantageScore 4.0 incorporates trended credit data in the calculation of your credit score. This data covers your balances and your credit line over the past two years. By gaining a longer view of your credit behaviour than what the traditional credit reports provide, the lenders can get a deeper insight into your borrowing and payment patterns. The significant changes in your credit behaviour over time will be especially beneficial if you’ve had bad credit in the past but have since made efforts to make on-time payments and settle your debts within the agreed period.

 

Credit scoring models are constantly evolving. Today’s most important factor in deciding a borrower’s creditworthiness may not be that much influential in the future. However, it is best to have a debt management plan to help you efficiently manage your credits.

Loans For People With Bad Credit provides bad credit loans to people across Australia. If you have a bad credit score but wants to secure financing, call us today on 1300 769 384 or fill out our Bad Credit Loan Pre-Approval form now.

 

See also:

5 Habits that Ruin Your Credit Score

What Are Credit Bureaus and How Do They Affect Your Loan Application?

How to Consolidate Your Debt if You Have Bad Credit

Angela Monroe
Angela Monroe is the Community Manager at The Positive Group, specialising in giving people the information that they need when they need it, and putting you on the path to a fair financial future. She has 8 years of experience in helping Australians find the right finance solutions, and regularly contributes articles to empower Australians with the knowledge they need to become financially healthy.

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