How many times have you been denied a personal loan request? Each time you are told the same reason – you are too low on credit score. Disappointed and hopeless, you turn to someone claimed to be a bad credit personal loan specialist. Even worse, you may fall prey on exorbitantly high interest rates and hefty fees of payday loans or cash advances. You are likely to compromise and get along with such predatory lending practices if you are really in need of urgent cash.
If you can delay your personal loan requirements a little, you can find enough time to consider on the reasons why your credit history is not so good. This step is important to rectify any error that your credit report might have and take some concrete steps to improve your poor credit score. Understanding the details of FICO scoring system, the most used credit score in the US, will help you analyze your financial situation.
According to an estimate, FICO scores are used in about 10 billion decisions worldwide each year. Though it is not possible to learn the inner scoring system of the company, you may be able to know how your habits cause an effect on the overall score that is based on the credit history you obtain from any of the three reporting agencies – Equifax, Experian and TransUnion.
A typical credit report contains several different pieces of data reflecting your financial behavior in the past few years. To calculate FICO Score, these different pieces of data are grouped into five categories, which are generally referred to as the components of FICO Score. Understanding these components will help you improve your credit score.
- Checkered Payment History: About 35% of your credit score reflects on how you have made payments to lenders in the past. Credit cards, mortgages, installment loans, personal loans (secured as well as unsecured) – all are taken into account while creating a payment history of the borrower. Late payment and default on loans are major causes of a low credit score. Moreover, the impact is bigger with a larger loan amount. The point to be noted here is – Make timely payments and never default on loans.
- High Credit Utilization: The bulk of FICO credit score consists of two elements – payment history and credit utilization. While payment history accounts for 35% of the score, the borrower’s credit utilization is responsible for 30% of the same. What do you mean by credit utilization? It simply means how much of the available credit is being used by the borrower. For example, if you are using $29,000 from an available credit of $30,000, you are doing no good to your credit score. According to FICO, the best credit utilization ratio is 7%, but 10 to 20 percent usage is also good. So, you should try not to use more $6,000 if you are offered a revolving credit of $30,000 from a lender.
- No Credit History or a Short Length Credit History: You have to have a credit history to reflect on the score. This is what makes up 15% of the score. Suppose you never borrowed in your life. How will FICO know about your financial behavior and whether you are capable of paying back a loan? This is why it is difficult for the first time borrower to obtain a personal loan. This is also why you should not close an open credit account. The older your credit card or credit line account is, the better is your chance of maintaining a good credit score.
- Too Many Applications for New Credit: Don’t apply for too many credit cards, credit lines or loans in a short period of time. It only suggests how desperate you are for a fund. It may also indicate, although falsely, that you are in financial trouble. Each time you apply for a new credit, it contributes to the 10% of your credit score.
- No Variety in the Types of Credit Used: It is also highly recommended that you use a mix of loan options. Installment loans, mortgages, unsecured loans, credit lines and credit cards – all make a healthy mix of credit, which can benefit you when you apply for a new personal loan. Remember, this factor accounts for the last 10% of your credit score.