How does a credit score work?

A credit score is essentially a three-digit summary of your financial history that lenders use to predict how likely you are to repay borrowed money on time. It acts as a shortcut for banks, credit card companies, and landlords to assess your "creditworthiness."

Most credit scores (like the FICO score) are based on five key factors, each with a different level of influence:

1. Payment History (35%): This is the most important factor. It tracks whether you pay your bills on time. A single late payment can hurt your score, while a consistent record of on-time payments is the best way to build it.
2. Amounts Owed / Credit Utilization (30%): This looks at how much debt you have compared to your total available credit limits. Using a high percentage of your available credit (e.g., maxing out a card) suggests you might be overextended, which lowers your score. Keeping your utilization low—ideally under 30%—is generally recommended.
3. Length of Credit History (15%): This considers how long your credit accounts have been open and the average age of all your accounts. A longer history helps, as it gives lenders more data to see how you handle debt over time.
4. Credit Mix (10%): Lenders like to see that you can manage different types of credit, such as revolving credit (credit cards) and installment loans (like a car loan or student loan).
5. New Credit (10%): This tracks how many new accounts you have opened or requested recently. Applying for too many loans or credit cards in a short period can lower your score, as it may signal financial distress.

How it works in practice: When you apply for a loan, the lender requests your credit report from one of the major credit bureaus. They use an algorithm to process your data and assign you a score.

• A high score usually leads to lower interest rates and easier approval, because you are seen as "low risk."
• A low score can make it harder to get approved or result in much higher interest rates, because you are viewed as "higher risk."

It is important to remember that credit scores are dynamic; they change as you pay off balances, open new accounts, or miss payments, reflecting your current financial habits rather than just your past.