Whenever you apply for a loan package, lenders / credit providers have to make reasonable enquiries about your financial situation. They determine your credit worthiness and ability to make repayments by taking a look at your credit score. So, it is important that you know the components that make your score.
What are the Components of Credit Score?
Whilst the formulas for calculating scores are quite complex and secretive, its components are not a secret. To help you understand, here is a list of components along with their relevant percentage assigned to each component:
35% for your "Payment history" – Late payments on bills, such as a mortgage, credit card or automobile loan, etc. will cause score to drop. Bills paid on time will improve your score.
30% for "Credit utilization" – The ratio of your current revolving debt (such as credit card balances) to your total available revolving credit or credit limit will determine your credit utilization.
15% for Length of your credit history – The aging of your credit history can have a positive impact on your score.
10% for Types of credit used – You can benefit by having a history of managing different types of credit (eg mortgage loans, instalment loans, revolving credit, personal loans, etc.)
10% for Recent searches for credit – Hard credit enquiries, which occur when you apply for a credit card or home loan (revolving or otherwise), can hurt your score, especially, if done in great numbers. If you are "rate shopping" for a mortgage loan or auto loan (eg a fortnight or 45 days), you will likely not experience a meaningful decrease in your score as a result of the credit enquiries. As the scoring models consider all hard enquiries that occur within 14 or 45 days of each other, as only one.
What is the Impact of Credit Enquiries?
While all enquiries are recorded and displayed on your personal credit reports for two years, they have no effect after the first year because most credit scoring systems ignore them after 12 months.
Some enquiries (called "soft enquiries") are not considered by credit scoring systems and they do not have an impact on your score. Here is a list of "soft enquiries" that do not have an impact on your credit scoring:
>> A report obtained by you for personal use
>> A report obtained by the employer for employee verification, or
>> A report obtained by companies initiating pre-screened offers of loan or insurance
So, these are the components that determine your score. I sincerely hope this article increases your awareness of credit scores.