Your Credit Score is calculated using a myriad of algorithms based on a single premise: Do you show the possibility of becoming 90 days late on an account within the next two years? In that, your Credit is made up of five different categories listed in the chart below. Each Credit Bureau has a specific individual scoring model not known to the general public. However, all follow the standards set by Fair Isaac.
Your payment history accounts for 35% of your Credit Score. It is the biggest factor in the Fair Isaac scoring system. Any recent late payments are a big reflection that you will default, and your Credit Score will diminish. It’s quite simple: PAY YOUR BILLS ON TIME! That doesn’t mean putting your payment “in the mail” on the due date. It is imperative your payment be in their hands on or before the due date. Even being a day late could cause adverse issues. Yes, all credit purveyors are required to offer a grace period, which is typically ten days. The exact date you make your payment is recorded in the lender’s database. If you need to get funding from that specific lender, they will take into account when and how you have paid them in the past.
REMEMBER, the scoring model is based on your potential to go 90 days late on an account within the next two years. Any recent late payments are a big reflection that you will default, and your credit score plummets as a result. Your creditor cannot report you late unless you are 30 days late. But, they will claim they need ten days to process your payment also. So don’t think just because you mailed your payment on the due day that they will not report you late.
I counsel our everyone to avail themselves of electronic payment systems most creditors and banks have in place, which is safe and secure. If you need to take your payment to the last day due, you can do it online and be guaranteed it’s where it should be at the exact time. Some creditors even give you a discount to pay online and eliminate paper billing.
Credit Utilization Ratio (CUR)
The most misunderstood part of your Credit Score, are the amounts you owe in relation to the credit available. They account for 30% of your score. This is called Credit Utilization Ratio, or CUR. I constantly hear, “how can my scores be so low, I’ve paid all my bills on time?” Here’s the reality of it.
A lender has granted you a credit line of $10,000. If you have charged $2000 against the line, your CUR is 20%. If your CUR exceeds 30%, lenders start to get nervous, and your Credit Score will suffer a few points. If your CUR exceeds 50%, a red flag goes up, and your scores will go down drastically.
Above 70% and your scores will tank, especially if you have multiple revolving lines with high balances on each. The average American has 4.3 credit cards. Let’s say with each card there is at 55% CUR. Further, let’s say that each card in that position causes your score to go down 10 points. NOW MULTIPLY BY 4.3! A nice score of 730 will go into the 680’s, and your good credit is now below average.
READ: Adding Authorized Users
On a regular basis, I see people who have an unblemished Credit History yet have scores in the high 500’s or low 600’s. The culprit is their CUR. In today’s world, it can also prevent you from getting any new unsecured credit. When you pay these balances back below the “safe” thresh holds, your scores will immediately go back up.
However, the previous high balances are noted on your credit bureau report for future lenders to see. Pay your amounts as close to 1% as you can, but make sure you keep your balances below 30%. Don’t fall into the trap of moving all your balances to one card due to a low-interest rate. Spread them over several and pay down the high-interest cards quicker.
Length of Credit History
The length of your Credit History and the amounts of credit granted account for 15% of your score. DO NOT close old accounts. Closing old unused accounts can have a negative effect on your score. Old accounts are very valuable. If you have a credit card from years ago that is still open, keep it open. Charge small items regularly and pay the statement as agreed each month.
The longer you maintain an account the better for your score. This demonstrates to future lenders your ability to maintain credit on a long-term basis. Lenders like history length. You should also know how credit limits can help your score. Higher limits put a greater value on your credibility. Open accounts with high available credit show someone else has already put their trust in you. High limits already granted will put a lender at ease when they contemplate extending large amounts of new credit.
READ: Debt Snowball
When determining Credit History length, they mainly look at individual accounts. An account that has been opened and regularly used for a few years is going to influence your score more than a newly opened account that has only been used a few times. They also consider how long it has been since accounts were last used. An account that is opened but hasn’t been used in years will have little bearing compared to one that is opened and regularly used.
This is why it is near impossible to get to an 800 score at a young age. As you have more accounts throughout your life and your history grows over time, your scores will naturally increase due to this factor.
Being added as an authorized user to an account with a long pay history is another way to increase your scores. BUT, be careful how you do this. Any missteps and you can damage not only your Credit Score but also that of your co-signer.
Type of Credit Used
The mix of Credit you utilize is responsible for 10% of your score. The two types of credit reflected in your credit mix are “secured” and “unsecured”. Secured credit includes homes, cars and like items that “secure” your loan. Unsecured credit is made up of credit cards, department store cards, and personal loans. If you have not pledged collateral, it is considered unsecured.
Lenders become wary of too much unsecured credit as default rates tend to be higher. A perfect credit mix is a mortgage, vehicle payment and one each of Visa, MasterCard, and Discover. If you have a ton of credit cards, your Scores will be lowered. If you have several mortgages, your Scores will be lower. Any, “unhealthy” account mixes lower your Scores.
The preferred number of credit cards is three. This means you will have a higher Credit Score if you have three open credit cards than if you have two or less. BUT, don’t run out and cancel your cards just yet. REMEMBER, 30% of your Score is comprised of your balances in relation to your high credit limit. So keep your cards open, but focus on having three LARGE balance cards for maximum impact.
New Credit makes up the remaining 10% of your Score. New Credit is directly related to the number of inquiries you’ve incurred over the last several years. Each time you apply for a loan of any sort, the lender will “inquire” as to your creditworthiness, by “pulling” your Credit Report. Each of these inquiries can result in up to four points being deducted from your credit score.
There are two things to know here. First, pulling your own Credit Report DOES NOT count as a hard inquiry. It WILL NOT damage your Score. Second, built into the scoring system is a mechanism which allows a lender to pull your Reports multiple times without devastating effects.
For example, you are shopping for a mortgage.
You want to check pricing from several mortgage vendors. They all need to pull your Credit and do so. If this is within a two week period, your Score will only suffer from the first inquiry. If you apply for a mortgage today, your Scores might drop 1-4 points. But, if you apply for a car, a mortgage, and a few credit cards this week, your Scores could drop significantly. The same applies if you have 12 car dealers pull your Credit, OR if one dealer has 12 banks pull your Credit. A lot of Credit pulls in a short period of time will have a great impact on your Scores.
Yes, all Inquiries will show and will remain on your Credit Report for six months to two years. However, your Score will not suffer from each individual pull. The same thing applies to a vehicle or other secured loan. The FCRA allows you two free Inquiries per month per Bureau without “dinging” your Credit. As they say,
“Don’t spend them all in one place.” *
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Click on the cover to the right to go grab your copy today, before I increase the price!
* Excerpted from my book “HT Credit Solution.”