In Back to Basics: What’s on my Credit Report, I detailed the types of items on your credit report. As a follow up, let’s breakdown what comprises your credit score.
The credit scoring system, whether the credit bureau uses VantageScore 3.0, like TransUnion, or the long standing FICO, places importance on certain factors of your credit history. There are 5 aspects to what comprises your score. This may be more information than you need to know, but knowledge is power and this knowledge will empower you when making decisions about maintaining or building your credit history. From most important to least, the 5 aspects are:
1) PAYMENT HISTORY: 35 percent of your credit score is determined by your payment history. Above all else, MAKE YOUR PAYMENTS ON TIME. I am not one of the counselors that advises clients to pay their credit cards in full every month. If it’s possible, by all means. However, the majority of Americans carry a balance on their cards monthly and if you are setting financial goals, they should be measurable and attainable.
2) DEBT USAGE: Credit card utilization is 30 percent of your credit score. Ironically, you should keep your credit card limit to balance at 30 percent or lower as well. When attempting to optimize your credit score this is a key component to raising your credit score. For example, a credit card with a limit of $3000 should have a balance no more than $900 to take full advantage of this portion of the credit scoring formula. Read, To Increase or Not to Increase, that is the Question, for a more in depth explanation of credit card utilization.
Let’s pause here and evaluate the top 2 categories that make up your credit score. 65 percent of your credit score is determined by how well you pay your creditors and how much credit you use in relation to how much you have at your disposal. What this means is that the greatest positive impact you can have on your credit score is to pay on time and reduce your credit card debt. An absolute great place to start if you are repairing or establishing your credit history.
3) LENGTH OF CREDIT HISTORY: One of the biggest mistakes consumers make is closing credit accounts, especially old accounts with a good history of payments. The length of time you have had credit is 15 percent of your credit score. After following my advice from reading my previous articles, you discovered by checking your credit report that you still have the open account you received in college from XYZ store because they were giving out free tshirts and candy. The store isn’t even located in the state where you currently live so you decide to close it. Closing accounts with a long history only hurts your credit score. Closing those credit accounts eliminates them from consideration by the scoring system. Potentially, instead of having a 20 year history, it’s only 7, 8 or 9 years. Still a good history but not as good as 20 years. My advice is, “Do not close old accounts and do not allow them to be closed by the creditor.”
4) MIX: The mix or different forms of credit you carry is 10 percent of your credit score. This category is not as significant as paying your bills on time; however, establishing good credit with a mortgage, auto loan, installment loan, credit card, and student loan demonstrates your ability to be responsible with credit of all types.
5) INQUIRIES: Lastly, at 10 percent, inquiries play a significant role in your credit score. You may be thinking: How so, if inquiries are the least important of the 5 categories? Before I answer the question, let me explain what an inquiry is and the different types of inquiries. An inquiry is just what it sounds like. Some entity is inquiring or seeking to review your credit report. There are “hard” and “soft” inquiries. Soft inquiries do not affect your credit score. Pre-approved solicitations, potential employers, and typically apartment rental applications are examples of soft inquiries. That being said, a hard inquiry is recorded on your credit report, and they reduce your credit score. Applying for a mortgage, auto loan, store and bank credit cards are examples of hard inquiries. Therefore, it’s important to only apply for credit when necessary. Each hard inquiry directly, negatively impacts your credit score.
There’s the breakdown. If you are looking to improve your credit score, the first 2 items listed above are within your power today, and they affect your credit score the most. Managing these 5 aspects of the system will lead you to increased Credit Swagger. Come back…stay tuned for more great reads from The 800 Credit Score Man.