Monday - Nov 20, 2017

What is Credit score? What is the impact when you apply for credit?


In an earlier post, we have referenced 2 credit card offers that can yield you over 100,000 miles. But, before you apply for credit cards you need to ensure that you have good and stable credit history.

In United Stated of America, you might have heard the term Credit History. when you apply for a Home Loan, Car Loan, Credit Card… Banks/Lenders want to know the risk of lending money to you. Every time you apply for a loan/credit card, lenders will look at your credit history to make the  decision  and an important piece of Credit History is Credit Score.

What is Credit Score? 

Credit score is a number calculated based on several factors from your credit history. Banks/lenders use FICO scores to determine your credit worthiness for lending you money. FICO scores ranges from  300-850 and the higher the number, the better chance of your loan approval.

There are 3 main credit bureaus in USA: Experian, Equifax and Transunion. Each bureau will have one FICO score. Banks/lenders usually request a credit report from one or more of these bureaus and make a decision about your request for credit. When a credit report is requested by a bank to make credit decision, a hard inquiry will be placed on your credit report.

What makes up Credit Score?

The FICO Score is calculated from several different pieces of credit data in your credit report. This data is grouped into five categories as outlined below. The percentages in the chart reflect how important each of the categories is in determining how your FICO Score is calculated.

Your FICO Score considers both positive and negative information in your credit report. Late payments will lower your FICO Score, but establishing or re-establishing a good track record of making payments on time will raise your score.

How a FICO Score breaks down

FICO credit score chart

Your payments history weighs 35% of your credit score

Why is it important to have a good credit score?

As mentioned, if you have a poor credit history, your credit requests will not be approved. Even if you are approved, the interest rates could be higher. Your credit score usually reflects the health of your credit history.

For credit cards that offers miles and points, they are usually considered as premium products, and I personally would not apply for these cards if the credit score is less than 720.

Does applying for credit cards impact the credit score?

When you apply for new credit, the 2 factors “Length of the credit history” and “New Credit” may impact your credit score in a negative way. However, in the long run, your credit score may improve based on the factor “Amounts owed

Length of credit history (15% weightage):

Let us say if you have 1 credit card that is 1 year old, when you apply for a new credit card and was approved. your credit will list 2 credit cards (1 year old and 0 years), your average of accounts drops to 6 months. This may impact your credit score in a negative way.

New Credit (10% weightage):

Whenever you apply for credit report, a hard inquiry is reported on your credit report. Banks considers more credit inquiries on your credit report as a risk. But the general conclusion is, impact of the hard inquiry will reduce as it ages (a hard inquiry that is 12 months old has less impact that a  hard inquiry that is 3 months old)

The impact of the credit applications on a credit score is not exactly known as the algorithm is considered confidential. In my experience, credit score is more sensitive to a hard inquiry if the credit history is short.

Amounts owed (30% weightage)

On the bright side, your credit score can also improve when you are approved for new cards. Let us say you have one card with a credit limit of $1,000 and you are now approved for another credit card with an additional $1,000 credit limit. Assume that your usage of credit limit on the first card is approximately $500.

If your credit usage remains same even with 2 credit cards ($500 in this example), the factor Amounts owed will drop from 50% ($500 usage on a $1,000 limit) to 25% ($500 usage on a $2,000 limit).  This could help improve your score as this factor weights 30% weightage on your credit score.

How to establish a credit score?

There’s really not much to it; in order for a FICO score to be calculated, a credit report must contain these minimum requirements:

  • At least one account that has been open for six months or more
  • At least one undisputed account that has been reported to the credit bureau with in the past six months
  • No indication of deceased on the credit report (Please note: if you share an account with another person this may affect you if the other account holder is reported deceased).

Conclusion:

Credit card sign up bonuses are on the easiest ways to rack up miles and points. It is important to understand the importance of credit score to improve the chances of credit approval.

Tomorrow, we will go through the options of getting your first credit card, if you are new to United states of America.

Editorial Disclaimer: Content provided on this site including any opinions, analysis, information provided here are those of the author’s alone, and have not been reviewed, approved or endorsed by any Airlines, Financial Institutions or Experts.

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