A good credit score is vital to your financial health. It helps you to build your better financial future in many ways. But, credit scores can be confusing to understand. Have you ever wondered how your credit score is calculated?
Understanding how your credit score is calculated can help you to improve it and make better financial decisions. Below we’ll look at how credit bureaus calculate your credit score.
What is a Credit Score?
Credit bureaus measure your ability to repay your debt by calculating your credit score. This effectively tells other financial institutions how worthy and able you are to carry credit. The 4 largest credit bureaus who create credit reports in South Africa are:
Credit bureaus work to keep track of your financial history here in South Africa. They take this history and turn it into a document called your credit report. The information on your credit report translates to a single score that basically rates your ability to repay debt. A credit score usually ranges between 0 and 999. Higher scores are considered stronger and better. Lower scores are not so good.
Why Does My Credit Score Differ with Other Credit Bureaus?
So maybe you already got your credit score from more than one credit bureau. Perhaps you’ve noticed that it differs. Why does it differ?
Credit scores differ between credit bureaus because they have their own way of calculating your score. Credit bureaus also don’t have the same information about you. Some lenders don’t report to all credit bureaus. It’s normal for your score to differ slightly from one credit bureau to another.
Why Does My Credit Score Matter?
So why does it matter? You earn an income or a salary and that’s probably the only thing that matters, right? Unfortunately, not.
Lenders are not only concerned about your income. They also want to know whether you can manage debt. And a good credit score will put them at ease. Remember, you basically need to “convince” the lender that you will repay the debt. And that is why your credit score matters. Lenders want to see how you’ve managed debt in the past before they will grant you more.
The Big Question: How Do Credit Bureaus Calculate Your Score?
So how do they calculate it? What determines your credit score?
Your total credit score is made up of different categories. Each category counts toward a specific percentage of your credit score. It’s difficult to pinpoint exactly what weight each category counts towards your total credit score because each credit bureau has its own method, but we’ve done some heavy digging and created the averages most people can people depend on. The breakdown below will give you a great idea of where to focus on improving your credit score.
*Please note, the amounts that follow are estimates because each credit bureau has its own way of calculating your score.
Payment History – 35%
Payment history is probably the most important category. It determines about 35% of your credit score. Paying on time gives you a better score. Lenders want to know if you pay on time.
Debt Utilization -30%
This category determines about 30% of your credit score. It measures how much debt you use. You have a specific total of debt available to you and this category measures how much you use.
Let’s say you have a credit card, for instance. You will score well in this category if you use less than 30% of the available balance on your credit card. This principle counts for the rest of your accounts and credit cards as well. Make sure you don’t use more than 30% of the total credit available to you.
Credit History Length – 15%
The age of your credit report also counts towards your score. It determines about 15% of your total credit score. Older credit reports score more points here. Lenders want to see your faithfulness over a longer period of time. They trust older credit reports more. Whether it’s a good score or a bad score, an older record helps to predict future patterns.
Recent Activity – 10%
Lenders want to know if you have been applying for credit lately. This category counts for about 10% of the total of your credit score. Lenders judge customers as risky when they apply for credit regularly. You will score points here if you refrain from applying for more credit on a regular basis.
Credit Mix – 10%
All the different kinds of debt you own are called your credit mix. This category counts about 10% towards your credit score. Lenders would like to know if you can manage different types of credit at the same time. You’ll score more points here if you own more types of credit. Here follows a short list of the types of accounts and credit considered in this category.
- Credit cards
- Personal loans
- Car loans
- Home loans
- Accounts and subscriptions (cell phone, gym, health insurance, etc.)
This is just a few of the types of credit. They may consider many more. Please also note that these percentages are an estimate. Each credit bureau may change these estimated percentages according to their opinion and experience.
5 Steps to Improving Your Credit Score
It’s good to know your credit score. But what can you do to improve it? Here are a few things you can do that will improve your credit score. Credit reports take a while to update. It may take more than 6 months before you see a noticeable difference in your credit score.
1. Pay Off Old Debt
Pay on time to keep a good score and settle your debt completely. It also limits the amount of interest you repay. Just remember to use your credit cards every now and then, but don’t let your card balances go into debt beyond what you can repay.
2. Avoid Regular Applications for More Credit
As mentioned earlier, don’t apply for credit on a regular basis. Whether it is for a loan or a credit card. It’s all the same because you request credit (debt). A regular need for credit indicates someone is spending more than what they earn. This leads to insolvency (owning more debt than assets) and eventually bankruptcy.
3. Don’t Use All Your Available Credit
Use less than 30% of your available credit. It shows you know how to manage the credit you have.
4. Don’t Close Old Credit Accounts
Don’t close credit accounts once you’ve repaid it. You can destroy your physical credit card if you are afraid of overspending again. But don’t close the account since it will remove the credit history attached to it.
5. Correct Errors Found on Your Credit Report
Credit bureaus have made mistakes in the past. Lenders may also make mistakes when they report to credit bureaus. Go through your credit report and ask to change or remove any errors. For example, you may have settled an account long ago, but it still hasn’t been updated to your report. Inform the necessary institutions to get it fixed.
Your credit score has an immense impact on your financial wealth. It determines the type of loan offers you get. You can only improve it if you know how to do it. And now you know how it is calculated. Start improving your credit score today by getting your free credit score on MyFincheck!