In an earlier post, I talked about credit scores and touched a little upon its core components. I mentioned the importance of having a good score and gave a brief synopsis on the history of the FICO scoring system. I gave a general breakdown on the biggest factors that make up your credit score. But what does it really all mean? How can you benefit?
A Little Recap…
As mentioned previously, your FICO score is calculated based on the following factors: Payment History (35%), Outstanding Debt (30%), Length of Credit History (15%), New Credit (10%), and Credit Mix (10%). Although we don’t know much about the actual formula used to calculate your credit scores, how can we leverage what we do know to make sure our scores are always in tip top shape?
Paying on time pays off! A huge part of your credit score is determined by your payment history. Creditors want to make sure you can pay off borrowed funds – otherwise what would make them want to let you borrow their money? If you pay on time ALL of the time, you should be in good shape.
How much do you currently owe in credit cards? Keeping your credit utilization low will always affect your credit score positively. This shows creditors that you can manage debt and use credit responsibly. The best rule of thumb is to always use 20% of your available credit and making sure your payoff monthly balances in full. You don’t want to use more credit than you can pay off because that can lead to credit default which can really hurt your score.
Length of Credit History
How long have you had credit for? A good credit history length shows that you have been able to use credit for a long period of time without defaulting. Managing this factor of your credit score can be kind of tricky, but doable. A big mistake people often make is closing old credit card accounts they don’t use. Although it may seem like a great idea at first, this can actually hurt your score in multiple ways. Closing old accounts will nix out the credit history length you have with that account which would make your average length shorter. Additionally, it also reduces the amount of credit you have available which can negatively affect you if you have a high credit utilization rate.
Tip: Check the length of credit history in all your cards. If you are thinking about closing one of your credit card accounts, consider how it may impact your score.
Have you opened up a new credit account recently? How many time have you applied for a credit card in the last year? These are some of the questions you should ask yourself when assessing this credit score factor. While opening up new accounts may increase the amount of credit available to you and lower your credit utilization rate, applying too much too often may cause serious concerns for creditors. Every time you apply for a credit card, creditors do a “hard pull” of your credit history. When you apply too often for new credit, it may make it seem you are desperate to obtain more purchasing power and are more likely to get into a huge amount of uncollectible debt.
What types of credit accounts do you have? This factor is low impact but should not be overlooked. Essentially, this piece tells creditors if you have student loans, mortgages, credit cards, auto loans, etc. This is extremely important to creditors because not all credit is created equal. Credit Mix helps paint the creditor the “big picture” of your credit profile.