Credit scores are a major factor used to determine if someone is credit-worthy. Most people acknowledge the purpose of the score but do not necessarily understand how they are determined or how to improve low scores. Here are some often-asked questions concerning credit scores, along with some detailed answers to help you understand them better.
How Are They Determined?
There are three major credit reporting agencies (CRA) in the United States. Each CRA is independent of the others; meaning that some of the information collected by one agency may not be collected by another. This is usually due to business agreements between banks and lenders, and the agencies.
Credit scores generated by the three CRAs will differ slightly (sometimes not-so-slightly) because of the varied information available to each. Also, not every creditor reports to the agencies, or they report irregularly, which ends up omitting information from your credit report and affects your credit score.
Your credit score is generated based on a percentage of five categories within your credit report. Payment history is the top category, accounting for 35% of your score. This is why it is important to stay on top of your minimum monthly payments and not allow any late payments to extend past 29 days. Lenders report delinquent payments at 30-days.
Not only do you adversely affect your credit score, you also cost yourself more because of late fees. Your history also includes information on charge-offs, accounts sent to collection agencies, bankruptcies, and other such details.
Utilization ratio is the next major category. The amount you owe to all accounts makes up 30% of your score. More than just what is owed; it is what you owe compared to the sum of all credit limits.
If you take your total balances and divide them by your combined credit limits, you will come out with a percentage. This number should be as low as possible, approximately 10-15%. A percentage higher than 30% is negatively impacting your credit score.
The length of credit history (15% of your credit score) looks at how long your accounts have been open. Older accounts of five years or more are good to have as long as they are current or paid off. New credit (10%) could potentially damage your score if you opened several accounts in a short period of time. Especially if the accounts are credit cards, this could indicate irresponsible activities or a reduction in income which would make it harder for these new accounts to be kept current.
The types of credit being used (the final 10%) are also important. Mortgages, student loans, unsecured credit cards or revolving credit accounts (ones that do not require a deposit or collateral), car loans, and more are all taken into account when your credit score is generated.
How Often Do They Update?
Your credit score updates upon each inquiry. This means that, depending on when a creditor reports to one of the CRAs, and the activities being reported, your score can change daily.
Reports to the credit reporting agencies are usually sent monthly, however. These reports contain a great deal of information that influences your scores. Your account balances and the timeliness of your payments are included in these updates.
The status of each account is extremely important. One in good standing or closed (with a good payment history) is improving your score while an account that is delinquent (30 days or more behind in repayment) or in collections is hurting you. When a negative item is reported, it will affect your score for quite some time!
How Long Do Negative Reports Last?
On average, the amount of time a negative item stays on your report is seven years! This can include delinquencies on accounts, starting from the original delinquency date; charge-off accounts, where the creditor has given up attempts to collect a debt; accounts in collections, when the original creditor has sold the debt to a third-party who will attempt to collect the debt; and house or property foreclosures.
Judgements against you can remain on your credit report for more than seven years if the statute of limitations runs longer. Bankruptcies do not disappear for ten years! These negatives do not just sit there on your report; they continue to impact both your credit score and your ability to open or expand existing accounts for the duration.
How to Improve Low Scores?
With patience. Lots of patience! Results do not occur overnight. You will have to remain diligent to improve your credit score. Be prepared to budget and sacrifice. In the end it will be worth it. Trying to buy a house? Want to take a vacation to Australia? Fixing your credit score will help improve those possibilities!
Make those minimum monthly payments on time! This is probably the most simplistic thing you can do for your credit score. If you have a history of delinquencies, there is nothing you can do about them; focus on the future. Plan ahead and build your budget.
If you are able to include additional amounts to your payments then plan to do so. Do not add extra to one account one month then a different one the next. Do not try and spread that little bit extra across several accounts. Concentrate your effort.
Two methods are used in these circumstances. Debt Avalanching allows you to pay off your debt quicker by focusing on clearing the account with the highest interest rate first, then move down the list to the next-highest rated account.
Debt Snowballing, in contrast, focuses on wiping out the account with the smallest debt first, then make your way up to the largest account.
Keep an eye on your credit report. With identity theft running rampant, it is important to maintain the accuracy of information on your report. Not only should you dispute suspicious activities with the CRAs, you should also take the time to clean up any inaccuracies present and include any forgotten accounts into your debt reduction plan.