Being Smart About Credit Can Make All The Difference
Understanding how credit works is an essential stop on the road to financial freedom. From financing a new vehicle to obtaining a mortgage on your dream home, credit plays an important role in your financial life. A good score can open doors to possibilities, while a poor score may limit your options.
The good news is that even if you don’t have a great credit score, you can fix it with actions and behaviors that will positively impact your score, like making payments on time. Your score won’t improve overnight, but by doing all the right things consistently, you can be sure it will go up over time.
Maintaining a proactive approach to your credit by keeping an eye on your credit reports and seeking to improve your credit score will help you make informed financial decisions. Let’s start with the basics to get you on your way.
What Makes Up Your Credit Score
You hear a lot about credit scores, but how does the number add up? For our purposes, we’ll be discussing the FICO score, the most commonly used score in the country. Basically, it’s determined by five key factors:
Payment History
This is the most important factor, making up more than a third of your score. Why? A solid payment history means you take financial commitments seriously and pay your bills on time. Lenders like to see that.
Credit Utilization
A fancy term for everything you owe—student debt, auto loans, credit cards and others—compared to your total available credit. Experts recommend keeping your credit utilization ratio below 30 percent. It’s the second most important factor in your score because lenders won’t lend if they think you’re in over your head.
Length of History
Still have the very first credit card you’ve ever opened? Good! Having established credit accounts in good standing shows you’re responsible with credit. It’ll take more than a few years to start scoring well in this area, and the longer the better. As your credit accounts age, assuming they stay in good standing, so will the history component of your score, which makes up about 15% of the total.
Type of Credit
A small factor but important, this looks at the type of debt you have, whether secured (like a mortgage) or unsecured (like most credit cards). Having a diversity of account types in good standing can boost your credit score because it shows that you can handle a variety of debts, such as credit cards, student loans or a mortgage.
Credit Applications
While this is only 10% of your score, you can hurt yourself here by suddenly applying for lots of new credit in a short period. That’s taken as a sign you may be on thin ice financially. It’s wise to spread out what are referred to as “hard inquiries” of your credit report, which happen when a lender runs a thorough check on your credit. Be careful to note that more and more places have begun running hard credit inquiries, including cell phone providers and even furniture leasing stores.
Who Comes Up With the Number
Your unique credit score is calculated by a scoring agency based on data from a credit bureau, which collects the data from your lenders, including banks, credit unions, credit card companies and more. There are many credit bureaus across the U.S., but the primary three used by the majority of financial institutions and businesses are Equifax, Experian and TransUnion. While multiple scoring models exist, the most commonly used credit scoring models are FICO and VantageScore, both of which create a score between 300 and 850—the higher the better.