Credit scores determine everything from eligibility for mortgages and car loans to opening a new credit card. But trying to understand your credit score can be unnecessarily complicated and intimidating. In order to try to help, here is a breakdown of the five categories that make up your FICO credit score in order of the percentage that they make up your score.
Your Financial History
Making up 35% of the reasoning behind your credit score, your financial history accounts for whether or not you have punctually paid your bills, whether or not you have ever filed for bankruptcy or foreclosed on your home, and is a compilation of all of your financial decisions from the past seven years. Every seven years, you get a fresh start, your credit history resets, and you have the opportunity to start fresh, but that can still vary depending on whether or not your debts carry over from the year change and other circumstantial financial details.
Missing a payment on your loan or your credit card is viewed the same way in the eyes of FICO. While those are judged in the same light, not all missed payments are created equally. It depends on the frequency and severity of missed payments as to how much that will impact your credit score. One of the main ways you can keep this a strong 35% is by paying all of your bills on time, and monitoring your expenses regularly so that they do not keep accumulating.
Your Utilization of Credit
If you max out your credit card often, or at least come close, then this portion of your credit score report may not be the strongest that it can be. While accounting for 30% of your cumulative score, this is the part of your credit report that takes into account your balances and your utilization rates on all of your accounts. This combined with your financial history are the most important parts of the credit score report, so be sure that these are the two strongest categories out of the five.
Furthermore, you can typically keep this 30% strong by having less than three thousand dollars in debts on all revolving accounts and a utilization ratio of six percent or less. They also tend to look favorably on accounts with three positive balances. Do not worry if you do not fit this demographic to the letter; these are just things that FICO looks for to grant high credit scores, and things that you can aspire towards as part of your financial planning for the future.
The Length of Your Credit History
Compromising 15% of your FICO score is the length of your credit history. A good rule to follow is that the older your lines of credit, then the better off your score will be. This is one of the multiple reasons that whenever your credit gets in a slump, it is ill-advised to open new trade lines to offset the negative accounts; it lowers the overall average age of your accounts, so it will end up hurting you more than helping you.
There is no need to worry, though, if you do not have that long of a credit history. It simply helps because it provides more information to FICO. Again, the major key to healthy credit lies in the other two categories that make up 65% percent of your credit score, so as long as you don’t miss many of your payments and have a relatively low credit utilization ratio, then you can still have a very high, healthy credit score.
Mix of Credit
These last two categories each make up 10%of your FICO credit score. Having a mix of credit means that you not only utilize revolving credit, but installment loans and other trade lines as well. The key, though, is not only that you use them, but you keep your payments in line and don’t get caught in debt in any particular type of trade line. The more that you prove that you are trustworthy with multiple types of credit, the higher your score, because lenders know that they can trust you to return their money to them in due time.
In order to get the most out of this sector of your credit score, whenever you decide to make a big ticket purchase and therefore need a loan, be sure to diversify the types of loans that you take out. While it is not the best indicator to FICO, studies have proven that people with multiple types of credit tend to be less risky than those that only take out one type of loan to make their large purchases.
Opening New Credit
If your credit gets to be in a slump, one of the biggest errors you can make is opening multiple trade lines at once in order to try to fix your financial hardships. While it is good to offset your negative balances with positive balances, it is also critical to keep the average age of your accounts old. There are also ways of paying off your debts that can help improve your credit score more than just opening new accounts and hoping for the best.
Another reason that opening a lot of new credit hurts your score is the effect of the hard inquiries that must come with new lines of credit. Hard inquiries, unlike you checking your credit score, negatively impact your credit score. These come whenever lenders have to check your credit in order to determine whether or not to loan to you in the first place. Only open new lines of credit when absolutely necessary.
Now that you understand where your credit score comes from, you have an understanding of what you can do to help raise your score and keep it at an optimal level that will allow you to make the financial decisions that you want to make and not have your financial future determined by a poor credit score. The world of credit scoring and credit management should be less mysterious to you now, so go forth and have no fear about having good credit and keeping it in good hands.