When I graduated, I never knew I would keep taking a test for the rest of my life. But essentially, that’s what a credit score is. It looks at how you’ve done with past loans and gives you a grade that is supposed to help predict if you will repay loans in the future. It also can help you land a job, rent an apartment, receive lower mortgage and car loan rates…the list goes on and on. So what makes up your credit score? And how can you achieve excellence, just like you did in school?
Five Factors
Even though I say credit score, there are actually two main credit scoring models that can result in slightly different scores among the three main credit bureaus. Neither the models (FICO or VantageScore) nor the credit bureaus (Equifax, Experian, and TransUnion) release exact information on how the score is figured. While your scores will vary slightly, paying attention to these five factors will help you achieve the best credit score you can.
Payment History (35%)
Do you pay your bills on time? That simple step is the biggest factor in your credit score. Lenders want to see people who regularly pay what they owe and pay it on time. They look closest at payments for car loans, mortgages, and credit cards; however, while utilities don’t report positive payments to a credit bureau, they will usually report any account that goes into default. Best bet – pay all your bills on time.
Credit Utilization (30%)
How much of your available credit are you using? This focuses on revolving debts like credit cards, where you have a set credit limit but no set monthly payment (other than the minimum). Most credit watchers say you should keep the amount you owe to less than 30% of your credit limit; some say to keep it to 10% or below. What that means is you don’t want to max out your credit card regularly. If you have a card limit of $10,000, keep the monthly spend under $3,000 and preferably around $1,000.
Age of Credit (15%)
Just as it says, this is how long you’ve used credit, specifically the average age of your accounts. And this is one instance in life where it’s good to be older. In fact, some advise you to keep your longest account active unless it’s imperative that you close it. However, if you’re new to credit, there’s nothing you can do to change this except keep using it wisely and let the age of your accounts build.
Mix of Credit (10%)
While age is an area that you can’t directly control, mix of credit is probably the most nebulous. Basically, credit scorers look for people who have an “appropriate” mix of installment (mortgage and car loan payments) and revolving (credit cards, lines of credit) accounts. What is appropriate? That’s anyone’s guess. But if it fits into your life, have a variety of accounts to show that you can manage various types of debts. Obviously don’t use mix of credit as an excuse to go buy a new car or house you can’t afford.
Credit Inquiries (10%)
How often you apply for credit translates into 10% of your score. When you apply for a loan, the lender will request your credit score. This category tracks what are known as hard inquiries, i.e. those where you are applying for new credit (car loan, student loan, credit card). Soft inquiries include when you request your credit report, reviews of your score by a company you’re currently doing business with (like your credit card company), or landlords checking your credit score. Too many hard inquiries in a set period of time will ding your score. Soft inquiries have no impact.
Note – if you are looking for a car loan or mortgage, the credit companies realize you will comparison shop. They will lump all similar inquiries and count them as one hard inquiry if they are pulled within 30 days (for FICO, others differ).
How can I improve my score?
Given all that goes into a credit score, there’s no ABC process that will help everyone raise their number. However, paying attention to these factors over time has been shown to promote scores across the board.
Check your credit report
For something that’s so important in everyone’s lives, the credit bureaus are notorious for getting their facts wrong. Maybe you’re listed as your mother or sister, who has bad credit. Maybe there’s someone on the account you don’t know. Maybe that late payment wasn’t late or there’s a company reporting a loan that isn’t yours. You can request your credit report from each bureau for free every year (some states provide more than one copy for free). Get it and pore over the details. If you see any problems, contact the bureau (there will be contact information provided) and stay on them to fix it.
My credit report is correct, but my score is bad
If you’re not able to pay your bills on time every month, you need to start by looking in the mirror. Are you spending too much (is this a life choice that’s been going on for years)? Or have you run into some difficulty of late and it’s affected your score? Whatever the case, maintaining a few habits will help:
Pay your bills on time. Remember the most important factor? Get your spending under control and work to start paying everything on time every month.
Watch your credit card balances. The credit utilization ratio can get out of whack quickly. If you’re going on a one-time trip to Europe, it won’t kill your credit to have a high bill. But again, if this is an ongoing problem, try to pare down your spending to less than 30% of your credit limit.
Don’t open and close accounts willy-nilly. Opening accounts will lead to more hard inquiries, while closing accounts reduces the amount of time you’ve had credit. Both will negatively impact your credit score. Determine what accounts you need and maintain them over time.
Stop obsessing about your score
I know people who check their score if not daily then several times a week. Stop. Just stop. While it’s important, a five- or ten-point move shouldn’t matter. Remember, this is about credit. If you aren’t going to need credit in the coming months, you needn’t worry about the small fluctuations. Check your credit reports periodically to make sure the data they have listed is accurate. And if you’re really curious or trying to increase your score, then check occasionally.
Once you are doing the fundamentals, trust yourself and enjoy the benefits great credit can provide.
Photo by David Pennington