What is Credit Report, Understand it!

ElitePersonalFinance
Last Update: February 13, 2021 Credit Report

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 crucial to get a mortgage, a new credit card, or a car loan.

What is My Credit Score?

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 accurately judges 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, you must know yours. Get your FREE annual credit report here!

3 bureaus in the US determine your credit score: Equifax, Experian, and TransUnion. Often, your score will differ across these, but typically not by a large margin.

What Determines My Credit Score? How is Credit Score Calculated?

Your credit score is determined, according to FICO, by 5 factors in the following way:

  • 35% – Payment history.
  • 30% – Amounts of money owed to creditors.
  • 15% – Length of credit history.
  • 10% – New credit.
  • 10% – Types of credit in use.

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).

What does your payment history include?

Your history on different types of accounts – The following types of accounts are taken into consideration on your credit history:

  • Credit cards issued by banks.
  • Retail credit cards.
  • Loans that are paid in installments (such as auto loans).
  • Mortgages.
  • Finance company accounts.

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 were your payments?

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?

Late payments that happened years ago have less impact as time goes on.

  • How much was owed?

Larger debt is more impact than a smaller one.

  • How many late payments are there?

One or two late payments will likely not harm you: however, your score will be lower if you have multiple late payments.

Overall, some important things:

  • Pay everything on time.
  • Pay more than the minimum payment.
  • Avoid, if at all possible, bankruptcy, liens, foreclosures, and lawsuits.
  • Never let anything go into collections.
  • If there are any negative impacts on your record, keep a perfect record for as long as possible as the effects of the missed payments and collections items will decrease over time – mistakes made while young do last but do not have to last forever.

Amounts Owed – How to Use This to Your Advantage

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. Even if you pay the balance off every month, your credit report may still show a balance on those cards since the credit report may not have updated.

  • Owed amounts across the different types of accounts

This means the amount of money owed by the type of account. It takes into consideration how much money is owed on some types of accounts over others. This refers to:

  • credit cards
  • retail store cards
  • auto loans
  • mortgages
  • and other types
  • 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 the 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.

How Can I Use This to Increase My Credit Score?

There are a few tips that you can use to make sure your credit score stays high.

  • Request credit increases from your bank without changing your spending habits. This way, your credit utilization stays low.
  • Keep accounts in a good stand and $0 balance on those that you use rarely.
  • Keep a small balance on cards that you use more frequently, make payments on them much larger than the minimum, and occasionally pay them off.
  • Take out installment loans that you can afford to pay back quickly.
  • In general, do not overextend your credit. Keep a large amount of available credit while keeping your usage of said credit low (but not zero).
  • Don’t open accounts that you do not intend to use.

Age of Credit History

It is common knowledge that longer credit history has a better score than a shorter one. 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.
  • Your credit accounts’ average age: 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:

  • Don’t close your first credit account. Instead, request a limit increase and continue using it, paying it off in full.
  • Open new accounts and keep them open. Do not open new accounts frequently over the years.

Types of Credit In Use: Keep a Diversified Credit Portfolio

Keeping different types of credit represents an overall low credit risk. This means you should have an appropriate mix of:

  • credit cards
  • installment loans
  • mortgage
  • retail accounts
  • finance company accounts

This, however, will typically not be a key factor in determining your score. However, it would help if you kept some things in mind:

  • Do not open accounts without the intent to use them.
  • Do not overextend your credit on one type of credit. Keep a diversified credit portfolio.

New Credit: Don’t Open Too Many Accounts at Once

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 overextension.

How To Overcome Bad Credit?

We will have a more in-depth article about this specifically. However, if you had had a period of bad credit (say you lost your job, ended up bankrupt, or were irresponsible when you were young), you can improve your credit over time and possibly earn a high score over a long enough period!

  • Improve your financial habits. Pay every payment on time. Pay credit accounts in full, or at least most of the way. Keep savings if things go south in your life, so you can continue making payments during a hard time.
  • Don’t close accounts with poor history. Keeping the account open and improving your payment habits on it will increase the average age of accounts AND give you the potential to increase your credit limit on that account. If you went bankrupt, start again with a secured card with a low limit and pay it off every month.
  • Wait a little while before opening a new account. You want to keep a high average age of accounts.
  • Decrease your credit utilization. You can do this either by (1) increasing your limit or (2) decreasing your spending on a credit card. It’s better to increase your limit, though.
  • Do not rush to open many new accounts! Open an account one at a time, over time, and be responsible.

Common Misconceptions About Credit Scores

  • Your income matters on your credit score. Your FICO score does NOT consider your income! However, lenders often WILL consider your income in addition to your FICO score.
  • Your occupation, race, gender, or location matter on your credit score. It does not, thanks to the Fair Credit Reporting act. This does not mean that lenders will not consider these things, however.
  • One late payment will kill your credit score. This is FALSE, especially over time. One missed payment is not the end of the world.
  • You cannot improve your credit after bankruptcy. This is also FALSE over time. Bankruptcy WILL hurt your credit score after it happens. However, they are struck from your record after a period of 7 to 10 years (depending on your jurisdiction), and within that time, you can develop a well-disciplined credit portfolio.

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