A lot of people stress out about their credit scores. Although the FICO credit score is just one thing that lenders look at, it’s often very important when trying to get a mortgage, a new credit card, or a car loan.
If you don’t know what a credit score is, your credit score is a numerical representation of your credit risk to lenders and creditors. Developed by FICO (once known as the Fair Isaac Corporation), this number is determined from a complicated algorithm that attempts to accurately judge how credit-worthy someone is.
Your score can range from 300 to 850, with a countrywide median of 713.
A higher credit score means that you are trusted with borrowing more money. A lower credit score means that you are less likely to be approved for loans and credit cards.
This score exists primarily to keep lending companies from making risky loans. However, it’s very important that you know yours. Get your FREE annual credit report here!
There are 3 bureaus in the US that determine your credit score: Equifax, Experian, and TransUnion. Often times, your score will differ across these, but typically not by a large margin.
Your credit score is determined, according to FICO, by 5 factors in the following way:
Payment History – The Biggest Factor
Your payment history is the biggest factor that determines your credit score. This is a little bit more complicated than ‘make all your payment on time’, though (although this is the most important part!)
Your history on different types of accounts – The following types of accounts are taken into consideration on your credit history:
If anything went into collections or is on public record – If you have a bankruptcy, foreclosure lien, lawsuit, or a judgment on your record, your FICO score will be impacted. Similarly, if anything went into collections, your score will be impacted.
How late your payments were: less than 30 days late is a much smaller impact than 90 days late. If you stop paying, your debt might go into collections which will have an even bigger effect.
How recently the late payment happened: a late payment that happened years ago has less and less impact as time goes on.
How much was owed: a larger debt is more impactful than a smaller one.
How many late payments there are: one or two late payments will likely do no harm to you: however if you have multiple late payments then your score will be lower.
Overall, some important things:
This factor makes up 30% of your FICO score and can be used in a smart way to raise your scores, in addition to making your payments every single month.
The amount of money owed translates into your credit score by considering:
Total amounts owed: This means the amount of money owed across all accounts. Keep in mind that even if you pay the balance off every month, your credit report may still show a balance on those cards, since the report may not have updated.
Owed amounts across the different types of accounts: This means the amount of money owed by type of account. It takes into consideration how much money is owed on some types of accounts over others. This refers to:
Whether you show an owed balance: On certain types of accounts (such as revolving credit lines and credit cards), you will want to carry a balance that is a small percentage of your total limit. We will explain how to use this to your advantage.
The number of accounts that have existing balances on them: If you have many accounts with balances on them, it might harm your score. However, if you keep the balances small, your score may not be affected.
How much (as a percentage) of your credit is being utilized: If you are close to maxing out your credit accounts, you may be overextended. This can harm your score.
Installment loans: A large percentage of money owed on an installment loan, such as an auto loan, may indicate overextension. If you pay down your installment loans quickly, you will have a better credit score.
There are a few tips that you can use to make sure your credit score stays high.
It is common knowledge that a longer credit history has a better score than a shorter one. This is because with a long credit history, there is a much more accurate assessment of credit risk.
What ‘credit age’ really means is three things:
How old your oldest account is: You want to have an account that has been open since the beginning of your credit history.
How old your newest account is: In general, if you have not created a new credit account in a long time, you will have a higher score.
The average age of your credit accounts: Your open credit account ages are averaged out and given an average age. The higher this age, the better your score.
If you want to increase your account age, here are some tips:
Keeping different types of credit represents an overall low credit risk. This means you should have an appropriate mix of:
This, however, will typically not be a key factor in determining your score. However, you should keep some things in mind:
If you’re young, it might be tempting to open 3 credit accounts, plus a car loan, plus student loans all at once. Don’t do this. Instead, opening one credit account at a time is a better way to increase your credit holdings without presenting the risk of over extension.
We will have a more in-depth article about this specifically. However, if you have had a period of bad credit (say you lost your job, ended up bankrupt, or you were irresponsible when you were young), you CAN improve your credit over time, and possibly earn a high score over a long enough period!
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