Understanding Your Credit Score

With changing lifestyles and the lure of instant gratification, it is no surprise that more and more people end up with a bad credit score. Today, it's easy to swipe that card when you want to buy something. Unfortunately, these financial habits of overcharging and not paying debts in full and on time have major consequences.

To avoid these consequences in the first place, it pays to understand what exactly a bad credit score is.

Defining Credit Scores

A credit score is comprised of several items including payment history, amount owed, length of credit history, new credit, and types of credit use. All these items are evaluated in order to come up with a three-digit number that represent your overall credit standing.

Credit agencies gather this information from lenders and providers to formulate your credit score. If your credit report shows that you have a history of late or missed payments on top of excessive credit card debts, chances are high that you'll end up with a bad credit score.

Breaking down the Basics

As mentioned, there are five main items that comprised your credit score. We'll try to break them down in details in this section.

Payment history

Payment history represents that biggest chunk of your credit score, 35% to be specific. If you want a good credit score, it basically boils down to paying your liabilities on time. By liabilities, it means all types of payments including your credit card bills, utility bills, loan payments and more. To help improve your payment habits, head over Investopedia for tips and tricks.

Amount Owed

The next biggest contributor to your credit score is amount owed at 30%. This generally refers to the amount of debt you owe in terms of loans and revolving lines of credit. That's mainly credit card debt. Loans with fixed payments are often not part of the equation. To avoid bad credit, it is important to keep your credit card charges at minimum, ideal at 30% or below of your credit limit.

Length of credit history

Constituting 15% of your credit score is the length of your credit history. If you've been a credit user for a while, that's good news provided that your history shows how responsible and consistent of a payer you are The trick is to keep old accounts open because those accounts help boost your overall score in the end.

New credit

New credit accounts represent 10% of your credit score. Regarding this element, you need to be careful with opening new credit accounts as they may hurt your score in the hint. It doesn't mean you shouldn't open new accounts. You just need to avoid opening a lot of new credit accounts because that may imply that you are struggling financially.

Types of Credit Used

Another 10% of your credit score is attributed to the type of credit you use. The more diverse your credits are the better for your credit score. It would help if you have different types of loans such as installment loans and revolving lines of credit. Naturally, you'll have to manage all these credits responsibly in order for it to be useful for your overall credit score.