It’s no surprise that California residents are concerned about their credit. Interest rates hit their highest point since 1981 this year. At the same time, many wonder if rates have peaked or will continue to rise. Although interest rates do not directly affect your credit score, how they affect your budget could cause your scores to drop.
What is a credit score?
Companies use a scoring model to create credit scores. This mathematical formula incorporates several factors, including your current unpaid debt and payment history. However, it doesn’t stop there. It also considers:
- The type and number of loan accounts
- The age of the accounts
- The percentage of credit you currently use
- New credit applications
Scoring models also weigh your personal and past financial issues such as filing for bankruptcy, foreclosure or accounts sent to collection. Companies use your credit scores to predict how likely you are to make loan payments on time as well as:
- Whether to offer you a loan (credit card, auto loan, mortgage, etc.)
- The interest rate on that product
- The credit limit on the product
Multiple organizations calculate credit scores, and each uses its own formula. Consequently, you don’t have just one credit score.
What are the different credit scoring methods?
Most companies that use your credit score for decision-making will use a third-party service such as FICO. However, some organizations also use VantageScore. Both use a range of 300-850 to denote the creditworthiness of an individual.
The FICO Score was a game-changer when it was introduced in 1989. It enabled credit issuers to give fast loan approval to qualified buyers and revolutionized how institutions viewed credit. Currently, there are over a dozen versions of the FICO Score, modified to benefit specific industries.
VantageScore was introduced in 2006. Developed by the three primary credit bureaus, TransUnion, Equifax and Experian, the goal was to provide a predictive, easy-to-understand scoring model. While they use the same data, the factors have a different “weight.” This means that the scores generated by each are different.
What factors affect my credit score?
Whether you’re applying for a loan or trying to get a new apartment, the creditors will look at your credit score. They want to find out if you are likely to make future payments on time based on your financial history. The higher your score, the better your chances of receiving approval.
FICO
FICO uses five factors to calculate your score.
- Payment History – This factor makes up 35% of the score. It reflects the consistency of your on-time payment history.
- Amount You Owe – This is the total of all your combined debt, from credit cards to mortgages. This makes up 30% of your FICO score.
- Credit History Length – The longer your credit history, the higher the score, particularly if you have consistently made the required payments. It is 15% of your score.
- New Credit Applications – Credit inquiries occur whenever you apply for credit. Generally, these inquiries can negatively impact your score. However, if you are comparison shopping for a student loan, auto loan or mortgage and apply to multiple lenders, your credit score only reflects one inquiry if it’s done within a 45-day period.
- Credit Types – With a 10% weight, this can help increase your score if you use different credit types (e.g., credit card vs. vehicle loan)
VantageScore
VantageScore is a competitor to FICO. As mentioned earlier, it was developed by the three main credit bureaus to evaluate creditworthiness. Rather than assign specific percentages to its six decision-making factors, VantageScore uses categories: extremely influential, highly influential, moderately influential, and less influential.
- Payment history is extremely influential. This factor focuses on your past payment consistency.
- Credit Utilization is highly influential. It enables creditors to see what percentage of your current credit you use.
- Credit mix and age is highly influential. It allows lenders to confirm that you have long-term established credit. Different types of loans, from revolving credit to specific payments, are also attractive to creditors.
- The amount you owe is moderately influential. Keeping the balance on credit cards and revolving credit helps improve your scores. This indicates that not only do you pay on time, but you are also less likely to overextend and fall behind.
- Recent credit behavior is less influential. Although it is less important than your history, current behavior, especially if it differs from the past, can indicate to lenders whether you’re struggling financially.
- Available credit is also less influential. Again, while overall payment history carries more influence, lenders want to know if you’re using most of your available credit.
Due to the differences in the credit score calculations, you may have “Good” credit with one system and “Fair” or “Poor” with the other. It all depends on how you use the credit available.
How Do Higher Interest Rates Affect Credit?
Inflation is driving up prices from gas to groceries, power tools to protein shakes. It means you may not have as much disposable income as you used to. Credit cards are increasing the interest rate they charge in line with the federal rate; debt is getting more expensive.
For example, pull out a credit card statement from August 2022 and one from August 2021. Take a look at:
- How much of each month’s payment is interest
- The interest rate
You may find that the interest rate from August 2022 was two or more percent higher than last year. If you are making the same minimum payments as you were in 2021, the increased percentage points this year means your balance may be climbing. This may occur even if you haven’t made recent purchases. In some cases, you may find that your payment is almost entirely interest.
Increased balances mean you’re using more credit, and higher amounts of used credit may negatively impact your credit score. This could mean an increase of hundreds of dollars a month for Rancho Cucamonga residents with several credit cards and loans. If you have an adjustable-rate mortgage, you may find you can no longer afford the monthly payments. If you miss one or more installments, your credit will take a hit if the lender reports it to the credit bureaus.
Rancho Cucamonga Debt Relief
There are several debt relief options that could help you lower monthly payments and help you rebuild your credit scores. Debt consolidation, debt settlement, and bankruptcy are three of the most used options.
A legal professional can also ensure that creditors do not harass you and may be able to stop foreclosure or repossession. Learn more by contacting Terrence Fantauzzi at 909-552-1238 for a free, no-obligation consultation.