Today we are going to talk about the almighty Credit Score and if you’re here you probably want to know what it is and why it matters to you?
So first and foremost let’s talk about how your credit score is formed. When you first start your credit venture you will most likely run into one of these companies, a Lender or Creditor, and there are other types out there but they may fall under one of these categories in some form or another. For instance if you may have a school loan, auto loan, mortgage or credit cards. And what these Lenders do is report your activities to a credit bureau or they may even report it to a bunch of different credit bureaus but the biggest ones are Equifax, Experian and Transunion. And then these bureaus gather up all your information from all these different lenders to create a credit report and then based on that report they will use a scoring model to a Credit Score but since each company’s scoring model is different, you may see different scores depending on which company you look at.
Another way to look at it is… imagine if these Lenders were Teachers for different subjects like Math, Science, English and so forth… And these teachers report your grades to the School (which is the Bureau) and the school collects all your grades from all the teachers to create a Report Card (which is your Credit Report) and then they use that report card to form your GPA, which is your Credit Score. The higher the score the more schools you get accepted into and this works almost the same when it comes to applying for a Loan or Credit Card.
Alright so now you know where your score comes from the first thing you need to do is get your Credit Report. You are entitled to a free copy of your credit report every 12 months from the 3 nationwide credit reporting companies which you can get from the annualcreditreport.com which is the only website authorized by the Federal Trade Commission for free credit reports.I utilize my credit to do so many things so it really helps remind me what accounts I’ve been opening and closing.
Identity Theft is a huge concern and it could really do some severe damage to your credit so you really want to keep tabs on it. Once you get your report, the first thing you are going to want to do is go through the report to see if anything seems off like if there is a loan or credit line opened and you did not authorize it and if there is something suspicious on there then you want to dispute it as soon as possible and depending on what it is, it could be easy to get it removed from your report but it may take some time for it to no longer show on your report.
So your report looks fine and you don’t see anything unusual but you don’t see your score… even though an annual credit report is authorized by the Federal Trade Commission doesn’t necessarily mean they are the ones issuing the Credit Score. So how do you get it?
If you already have a reputable Credit Card then the chances are they will provide you with a Credit score from one of the bureaus or maybe all three since the companies also that same metric to measure you when you apply for their services so they are just letting you see it your own score for using their services.
I also recommend you to try out these FREE web services that give you a pretty good estimate of your score with tons of other features as well but you have to pay if you want the premium features.
By now you’re looking at your credit score and you may be wondering why the score looks different when you look at different places. And that’s because companies use different credit modeling types and there are certainly a lot of different types out there that these companies use but the main ones are your traditional score which most companies don’t use as much anymore since most of them are now using the FICO score as the norm and then there is also the Vantage Score. Another reason why your score looks different depending on when the scores get updated either from the Lender, Bureau, and Score services, typically it may take several weeks for your score to stabilize. I had one Lender that didn’t update for a month and it didn’t stabilize across my credit scores until 3 weeks later.
Well, what’s the difference? And to be honest with you, there are some differences but the way all the models measure you is based on a common concept. So if you are responsible with your credit, all your scores will increase, regardless of which score model you look at but at the same time if you’re not responsible then guess what… your score is going to drop dramatically, across the board.
Alright so let’s take a look at the Score ranges and we are going to focus on the FICO model since it’s one of the most widely used systems. Typically the range of score is between 300 to 850, 300 is the lowest and 850 being the highest. So if you take a look at the screen you should see the ranges and the score ranges are broken up into 5 parts ranging from Poor to Excellent. You want to try your best to be in the 800 + range because this is where you have the highest chance of getting approved for anything you apply for and this is also where you are going to get the best deals from Lenders like the 0% interest for an auto loan from certain dealerships.
Now don’t get me wrong, if you’re under 800, it doesn’t mean you won’t be able to get approved or find any good deals but you’ll just have a better chance if you score as high as possible. In my Opinion, You can get by pretty well if you least in the 700s but anything below that… you really shouldn’t be worried about applying for anything, you should be worried about paying off your debt and getting that score up.
Ok so depending on which model you’re looking at… your credit is going to be broken up into 4 to 6 parts so we are going to use a model in between that and do a 5 part chart.
So taking a look at the chart here we can see that the most important factor is the Payment History which makes up 35% of your credit and it is by far the most impactful factor of your credit . Lender’s want to make sure that you are making payments on time, every time because if you couldn’t pay in the past… you may not be able to pay them if they extend you some credit.
Mistakes can happen so most lenders usually forgive a missed payment. Sometimes a late payment does not register on your report, if it’s only a few days late, even though you may have to pay a penalty fee. but if it’s a few weeks late and it gets reported by your lender then that’s going to majorly affect your score and the Higher your score the harder you fall. Just remember that. So say if your score is 800 and you are late a payment for 30 days your score could drop 100 points and for someone like me who has gone through collections and deferred payments getting to 800 almost took me a lifetime so losing just 25 points is very painful, let alone losing 100 points, on the other hand if you score is only 660, even with 2 late payments, your score may only drop 60 points which would put you on the border of the Poor category. Frankly, there’s not much more points you could lose so the points will decrease as your score decreases.
The next factor is your credit utilization which makes up for 30% of your credit and it also has a high impact on your score. All this really is, is how much of your credit that you are using versus the total credit available to you. Just because a lender gives you a 10,000 dollar credit limit, it doesn’t mean you should use it all and max it out.
Ideally you want to keep your debt at 0% but you can get away with keeping less than 29% and still do pretty well for yourself… that is if you don’t mind paying the interest but I don’t recommend it.
For example if you have a $10,000 limit on one of your credit cards and you used $3,000 of it, which is 30% usage then it puts you in the GOOD category which isn’t bad but if you opened up another credit card with another $10,000 limit which gives you a total available credit of $20,000 and you spend that same $3,000 dollars then it’s only 15% utilization of your total available credit which puts you in the VERY GOOD category. Initially, you may take a slight decrease in your credit score for opening an account but within 1 or 2 months this will really help you increase your score.
And moving on to the next factor, we have the Credit Age or Credit History which makes up for 15% of your credit score and has a medium impact on your score. And this factor measures how established your credit is over the years and there’s not much you can do here but to just wait. The longer you keep an account open the better your Age or History is going to look. So if you keep your account open for over 2 years then your credit will automatically move up, so on and so forth. Keep in mind that this only calculates the accounts that are active not the accounts that you’ve already closed (Depending on which credit model you are looking at).
There’s only 2 mistakes you can make that will affect this factor. And that is closing an account and opening new accounts. Let me explain. So let’s say you have 3 credit cards that you’ve opened at different times say 10 years, 4 years, and 2 years ago. Your current Average Credit Age or History is 5 Years old which puts you in the Intermediate Range and you decide to close your oldest account of 10 years, maybe it had an annual fee that you’ve been paying and you just don’t want it anymore. Well by doing that your average age goes down to 3 years and your score drops 15 points. Keep in mind that your score could also drop from not only closing your oldest account but the decrease of available credit from that card you closed so be very careful on the card you decide to close. This is one of the very rare times I will say this but it might behoove you to keep that card open and pay the annual fee unless you are confident that your other credit factors can make up for the lost points.
Let’s see what happens to your score when you open a new account. Using the same example. Your current average credit Age is 5 years and you decide to open up a new credit card well now since you opened a new card your average age goes down a level range and your score drops. This is typically not really as bad as closing your oldest history but if you do it in moderation it can be managed to the point that it doesn’t drastically affect your credit. It typically will take around 4 years for your credit to build itself back up to the next level range again.
Well, what would happen if I close my most recent account? Good Question. This is one of those exceptions. If you close your earliest account, in this example it would be the 2 year old credit card. Your average credit age would actually increase from 5 years to 7 years which puts you in the next level range.
Alright so looking at the Accounts Factor or Account Mix or Total accounts… depends on which model you’re looking at… It only accounts for 10% of your credit score and the impact to your score is pretty low but it’s still important.
Lenders like to see a mix of different types of accounts on your report like auto loans, school loans, credit cards, mortgages and so forth. You don’t necessarily need to have different account mixes either, you can have 11 different credit cards and it’ll work. And the account doesn’t even need to stay active. So basically, as long as you opened over 10 accounts, you’ll be in the green. (Depending on which credit model you are looking at)
Last but not least we have the Inquires or New Credit which has a low impact on your score and it only 10% of your total credit makeup. Every time you apply for a line of credit, most likely the Lender will want to run your credit through the system to see if you are worthy to extend credit to and every time a Lender does this it’s going to count as an attempt to get credit. I say attempt because even if they run your credit it doesn’t mean they approve your line of credit but since the credit check has already been done, it still registers on your credit report. So you definitely want to make sure that you have a good chance of being approved for what you’re applying for before actually applying for it. So don’t go off applying for random credit lines and getting your credit check at a different Lender, remember every time you go to a Lender to apply for credit the lesser your chances of actually getting approved because your credit score is taking a hit with every Lender. So if you go to the first Lender and they decline you and then you go to the next Lender, you may notice your score is 5 points lower and then you try again and now your score is even lower.
So these Inquiries typically stay on your report for 2 years but each inquiry only directly affects your score for a year, so after a year… yea, the inquiry still shows up on your report but it doesn’t directly affect your score anymore. Although this may still affect your chances of getting approved if your credit score is borderline of being considered Good or lower. And since this factor doesn’t affect my score too much I’m ok with keeping a rotating balance of 4 inquiries a year but that’s only because my credit is established enough but if you credit needs work then you shouldn’t apply for any new lines of credit for at least a year or 2.
That pretty much sums up your Credit & Credit Score. There’s one thing I want to point out and I don’t know if you’ve noticed yet but each of these factors are linked to each other in one way or another. So changing one part of your credit could impact your score negatively or positively. I just want you to be mindful if you decide to close an account, be sure to check if closing it will affect your overall utilization or credit age. Or maybe you want to apply for a new credit card then make sure you don’t already have too many inquiries and see if it will affect your average credit age.
And you may still be saying, I have the money to pay for it, why would I need credit? And that’s a very valid point. It shows that you are a responsible person who is able to do that but not everyone may be in that same situation and everyone has different needs. And because you’re a responsible person, it makes it even more worthwhile for you to leverage your credit to help boost your finances even further.
So why is credit important?
- It may affect your ability to find a job. Some jobs, especially professional careers, will look at your credit report as a factor when deciding to hire you or not. If you can’t take care of your personal finances how can they expect you to be responsible with their multi-million dollar assets? Granted, this is not always true but it is a valid reason.
- Having a high credit rating may save you money on your bills. Some utility and entertainment services may look at your credit report to determine how much you have to pay. For instance, If you have poor credit they may require you to provide a down payment to activate your services or you may only qualify for certain services. On the other hand if you have great credit, you won’t need a down payment and you may qualify for a better service plan for a discounted rate.
- It improves your chances of getting approved for a credit line and lowers the interest rates that you get all the while giving you a higher ceiling or credit limit. This is pretty important when it comes to credit cards since some of these credit cards have a very strict criteria for approval but they always have the highest sign on bonuses and rewards.
- And Lastly, it helps with your ability to finance things such as school loans, auto loans and mortgages. Basically, it not only helps you qualify for the load but it also helps you finance any loan and the higher your credit, the less of a burden your loan becomes. Meaning, if you have excellent credit you could potentially save hundreds of thousands on a mortgage because you qualify for a lower interest rate than average.
Here are a few good tips for each credit factor.
- Payment History. Always, Always… Always pay on time. Can’t stress this one enough and if you can’t then try your best not to put of paying for too long because the longer you don’t pay the more impact it negatively does to your credit
- Credit Utilization. Keep your overall utilization under 30% at all times. I know it may be tempting to go and spend godly amounts on your credit but you may end up regretting it later. I personally like to keep my utilization at 0% but at most I would even go 10%.
- Credit Age. Try not close your oldest credit line unless your credit is established enough that even if you do close it, it won’t affect your score. I remember my first credit card has an annual fee and as much as I wanted to close that account, I had to keep it since I was going to get a mortgage for a house and I knew that closing it will drop my like 30 points and I would not get the best interest rates but after my credit stabilized, I immediately closed that account.
- Account Mix. Not much to say here… Just open 11 lines of credit and manage them properly. I’m not sure if this is a myth or not but people have reported that having a mix of auto loan, credit cards, school loans and mortgage makes a difference. I can somewhat agree with this for your overall credit score limit to go above the 800 score but as far as the factor itself… I do not see a difference.
- Inquires. Don’t just go opening random credit lines. Try not to open too many credit lines in a short period of time. Plan ahead and limit yourself on how many credit lines you should open and how often you should open based on your credit portfolio.
But the bottom line is if you are responsible with your credit and use it within moderation your credit portfolio will continue to grow along with your score.