Understanding Your Credit

Your credit score probably isn’t something you talk about or even think about on a daily basis, but your credit score is one of the most important aspects of your financial life when it comes to qualifying for a loan, securing a good interest rate, and the amount you pay for auto insurance, or even the types of job offers you receive.  That is why it’s even more important to understand your credit score and how it’s calculated by the credit bureaus.  So let’s jump in!

Now, the credit bureaus won’t give us an actual formula for determining a credit score.  Instead, they’ve given some broad parameters of the criteria that goes into creating credit scores.  This criteria includes both positive and negative information in your credit report.  For example, late payments can lower your credit score, but establishing or reestablishing a good track record of making payments will raise your score.

Next, we’ll look at the individual pieces that make up a credit score…

Payment History

The biggest and perhaps most familiar way a credit score is determined is from your payment history.  35% of your score comes from this.  Payment history reflects your bill payment habits.  The first thing any lender wants to know is whether you’ve paid past credit accounts.  Not only that, but are your payments on time, are they late, have you missed payments altogether?

Utilization

The next category is “utilization” or amounts owed.  This is 30% of your credit score.  What this category looks at is the amount of credit that you have versus the amount of credit you actually use.  When a high percentage of a person’s available credit has been used, this can indicate that a person is overextended and is more likely to make late payments, or even miss payments.  Let me give you an example.  You get a brand new credit card with a $1,000 credit line.  You max the card out and utilize 100% of the credit.  This is actually viewed negatively when it comes to credit scores.

On the other hand, using a low percentage of your available credit can have a positive impact!  In some cases, a low credit utilization ratio will have a more positive impact on your score than not using any of your available credit at all.

Credit History

OK, so the third thing that factors into your credit score is the length of your credit history.  This makes up for approximately 15% of your score.  In general, a longer credit history will increase your score.  They also take into account how long your credit accounts have been established, including the age of your oldest account, the age of your newest account, and… an average age of all your accounts.  So if you get a brand new credit card for your favorite department store, that’s not going to have as big of an impact as an account with which you have maintained a good relationship for several years.

The next two factors only make up a small percentage of your score, but they’re still important to understand.

New Credit

New credit will make up about 10% of your score.  People are shopping for new credit more frequently than ever before – and credit scores reflect that reality.  Research shows that opening several new credit accounts in a short period of time represents greater risk – especially for people who don’t have a long credit history.  Here’s a tip: if you’ve only been managing credit for a short time, don’t open a lot of new accounts too quickly.  It starts to look a bit desperate if you open new accounts and have multiple inquiries.

Credit Mix

Finally, your “credit mix” makes up the last 10%.  Your credit score will take into consideration your mix of credit cards, retail accounts, installment loans and mortgage loans.  It’s not a good idea to open credit accounts that you don’t intend to use, but, having credit cards and installment loans with a good payment history will actually raise your score.  People with no credit cards tend to be viewed as a higher risk than people who have managed cards responsibly.

So that’s the five criteria that will be used to judge your credit score.  If you have good credit right now, congratulations!  Try to protect it and keep that score high.  If your score is lower than you want it to be, here’s the good news.  You can change it.  Money coaches have seen thousands of credit scores go up through coaching appointments and a little bit of hard work.  Whether you want to improve your credit or maintain the great credit you already have, you can benefit from talking with a Money Coach who is a Certified Credit Counselor.  Together, you can create an action plan tailored to your lifestyle and financial goals.  Call 888-724-2326 to get started.