Do you know what makes up your credit score?
We bet that most people have no idea what goes into making up their credit score. That’s too bad because we also think that knowing how your credit score is determined can help you create good financial habits…the kind of good habits that can help you build a good credit history and a good credit score.
What is a credit score?
OK, let’s start really basic. Like any score, a credit score is a number that is used to measure performance. In this case, your credit score is measuring YOUR performance in managing your credit. Although there are actually many kinds of credit scores, when most people talk about credit scores, they are referring to their FICO credit score.
How is your FICO credit score calculated?
Nobody knows the exact formula. The people at the Fair Isaac Corporation (get it? FICO?) keep the formula secret. However, we do know that it is composed of 5 elements as shown in this image along with their approximate values:
Those credit score ingredients include the following:
- Payment History
- Amount of Outstanding Debt
- Length of Credit History
- Types of Credit Used
- New Credit Opened in the Last 3 to 6 Months
Do you pay your bills on time? When you do, do you pay the full amount that you owe?
We hope that you do because the largest piece of your credit score pie is made up of your history of paying your bills on time. Here are the proper ways of managing your payments:
- Make your payments on time
- Make your payments in full
- Show that you can use credit responsibly
- Make late payments
- Make partial payments
Do you keep your credit balances low?
The second largest piece of the credit score pie is determined by the amount of your available credit that you are actually using. When you use credit, you convert the amount you used from available credit to debt. Credit bureaus use the fancy term, Credit Utilization Ratio, to measure the percentage of available credit that you have converted to debt. The higher the percentage, the lower your credit score. So, here are your do’s and don’ts for actually using your available credit:
- Use your credit cards, but pay off the balances every month whenever possible
- When you must carry a balance, keep the balance under 30% of the available credit to build your credit score
- Let your balances stay above 50% as this will actually hurt your credit score
- Carry a balance at all on credit cards if you can afford to pay them off every month
Have you had credit for a long time?
15% of your credit score is based upon the length of your credit history. So, what does that mean? It means that having a credit card account or line of credit that has been open for a long time is good for your credit score.
- Keep old established credit accounts open
- Close credit card accounts after you pay them off, especially if you are about to apply for new credit…like a car loan or a mortgage
What kinds of credit accounts do you have?
We ask because your credit score goes up if you show that you can manage different types of credit. Examples are mortages, revolving credit like credit cards, and installment loans such as car loans and furniture.
- Use multiple types of credit
- Open accounts just to add to your “types of credit”
Have you opened up new credit in the last 3 to 6 months?
If you have, that will hurt your credit score.
- Keep in mind that is is a short term impact on your credit score
- Open new credit accounts unless necessary
Why do you even care?
OK, seriously? Your credit score determines just about every aspect of your financial life, including:
- Can you get approved for a loan?
- If you can get approved for a loan, how much will you pay in interest?
- Can you get an apartment?
- Can you get hired for some jobs?
- Can you get insurance and what rate will you pay?
- What rate will you pay for your cell phone?
- Can you establish utility services in your name?
By understanding how your credit score is put together, you can use that knowledge to your advantage. You can make decisions and establish financial habits that work in your favor. That hard work will turn into good credit scores that will lead to lower financial costs that will save you money for the rest of your life. You could save hundreds of dollars on every car loan and tens of thousands of dollars on your mortgage.
That good credit score could also turn into a better job that means thousands more in income every year of your life. All because you understand how you can turn information about credit scores into good financial habits. Way to go. A little bit of useful information can be a real game changer.
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If you’re struggling with your personal finances, our certified counselors have the experience to help you manage your money so that its not controlling you.
Find out more by calling 937.853.1600 or by visiting our Financial Counseling page.