Unless you’ve been living under a rock, chances are you’ve heard about how important credit scores are. Your credit score is what helps lenders determine how much money they can lend you with the least risk involved. This means that if you have a poor credit score, it would be close to impossible to take out loans you may need for big purchases like a house, an investment property, or a car.
The standard that is most commonly used by lenders around the country was created by data analytics company FICO, who fixed the score range at 300 to 850. Last year, FICO revealed that the national average credit score was at an all-time high, peaking at 704. This positive development comes from an increased awareness about credit scores, which translates to responsible credit maintenance.
Generally, a credit score above 700 is considered good and can likely get consumers what they want to borrow. Anything above 760 is excellent and takes more work and monitoring to achieve. Whether you’re trying to reach that high standard or are simply looking to boost your credit score, it’s important that you understand the biggest factors that affect it, as listed below:
Your bill payment history accounts for more than 1/3 of your credit score. This makes sense, as lenders are tasked to determine if you can pay back the funds that are loaned to you in full and on time. Things to consider in your payment history are how often you miss payments or submit them late. If your account has been flagged and sent to collections, this is a warning signal to the lender that you’re not a responsible credit user.
Thankfully, the late payment you made a decade ago won’t count for much today. That being said, you should never take credit payments for granted. If you aren’t already, keep a record of which monthly bills you have to pay and when they are due. Marcus’ guide to credit dos and don’ts emphasizes the importance of paying all your bills on time, as this can help improve your score by as much as 35% if your payment history is great. A useful trick is to add some extra pressure by adjusting the deadline you write down to one or two days before the actual deadline. No matter what your pending obligations are, the best time to start improving your payment history is today.
Your level of debt affects 30% of your score. Here, lenders consider your credit utilization, which is the ratio of what you owe to your available credit limit. For instance, if your credit limit is $1,500 and you use your card to make a purchase worth $1,400, then you’ve almost maxed out your limit.
While that may be an extreme example, you don’t need to owe that much for it to affect your score. In fact, an article on The Balance notes that if the amount you owe is more than 30% of your available credit, it could have a negative impact on your overall credit score. This is why it’s important to maintain realistic credit utilization across all your accounts to show lenders that you’re a responsible borrower and won’t max out your limits at the first opportunity.
Length of Credit History
15% of your credit score will depend on how long you’ve actually used credit. You can’t have a high credit score if you’re new to credit, as credit history is necessary for lenders to glean information about your financial behavior. Plus, having a long credit history shows that you have experience managing credit.
Because of this factor, it’s often recommended that you leave your credit accounts open, even if you don’t need them. The age of these accounts on their own are enough to improve your credit score substantially.
New credit makes up 10% of your credit score and is evaluated based on the number of new accounts you’ve applied for. This doesn’t mean that you should be opening new accounts left and right, as this could actually hurt your overall score. Our correspondent at Mashvisor, Sylvia Shalhout, warns against applying for multiple new cards because this is seen as a red flag by lenders who consider it risky behavior. People who take lots of new credit within a short period of time are often viewed as being in financial trouble. Additionally, keep in mind that every new account you open lowers your average credit age and, in turn, your overall score.
Thus, be sure to limit the number of times you apply for new credit lines every year. Consider applying for a new account as a last resort — something that should only be explored after you’ve exhausted all other options.
Types of Credit
But it’s not all just about quantity. While it carries little weight — 10% to be exact — the variety of credit lines you have can significantly influence a lender’s decision. This is because borrowers with multiple types of credit are seen as less risky, as they are responsible enough to manage a variety of credit lines.
Upon Arriving’s guide to credit mixing lists the different types of credit you need to know about. These are the installment, revolving, and open lines of credit. Having a mix of these three types means having student loans, personal loans, and utility payments, among others. This variety shows that your credit lines are diverse and that you are good at managing different types of loans.
This article has been contributed by Sheila Witte.