If you’ve been researching information on credit you’ve probably seen a lot of different information. On this blog site you’ll always see tips in each blog on how to improve your credit score. Today we’re going to focus on the 5 main factors that create your credit score. Many people believe not having collections and charge-offs or no credit cards at all will help them get the perfect credit score they want. That right there is completely wrong! It’s a lot more than just not having collections and charge-offs to have a good credit score and they’re completely wrong by thinking not having any credit cards at all will be better for them and still have a positive credit score. I use to be afraid of credit cards, NEVER wanted a credit card. I got my first credit card at 24 years old but now that I know how to handle them, I’m no longer afraid and have 5 active cards at the moment.(Surprisingly that’s still not enough) If you haven’t read my older blogs I’ll briefly recap on the best ways to handle your credit cards to improve or increase your credit score but give the exact break down of your credit score.
As mentioned earlier, your credit score is based on five different factors.
- New Credit/Inquiries
- Length of Credit History
- Type of Credit
- Amount Owed
- Payment History
10% of your credit score is based on new credit/inquiries. Applying for a new credit line can affect your credit score by 4-12 points alone. Whether you are approved or not for that new credit line you will still be hit with a new inquiry and will see a small credit score decrease but nothing too serious unless you are applying for a new credit line each month. Now let me be clear about one thing, your credit score can ONLY be affected by a hard inquiry. Some companies, like UrChoice Credit, do soft credit pulls… When you get a soft inquiry, your credit score is NOT affected and you are the only one that can see this credit inquiry on your report. A hard inquiry happens when a lender you’ve applied with for credit reviews your credit report as part of their decision-making process… A soft inquiry occurs when you check your own credit or when a lender or credit card company checks your credit to pre-approve you for an offer. I recommend to my clients at least two but no more than 4 hard inquiries a year, spreading them into every six months. Now sometimes you may have to shop around and have your credit score ran a few times within a few days, the credit bureaus would consider this as ONE inquiry. That’s called rate shopping, so while your score may only be affected by 4-12 points (one inquiry) by these inquiries each inquiry will still report on your credit report. You want to keep your inquiries at a minimal because if a creditor sees too many inquiries, they’ll think you are constantly shopping around for new loans.
15% of your credit score is based on your credit length history. The older your credit accounts are the better for you. One of my repetitive credit tips to my clients is DO NOT CLOSE ANY OF YOUR ACCOUNTS, even if you don’t use it. Allow the creditor themselves to close the credit account, honestly they will take longer to close an account for non-activity than if you were to close the account. Feel like closing an account? Just cut up the credit card you have and forget about the account. Just make sure before you forget about the account, the account is at a zero balance. Now obviously it’s not easy to have a perfect credit score if you have new credit but with on time payments and low credit utilization, you can achieve a great credit score. This is important because lenders typically like to see that you have experience borrowing responsibly. The older the account with great history, the more likely you will be approved for the loan. Check out the chart below from credit karma I used for a better break down.
Another 10% of your credit score is based on the type of credit you have. While this isn’t based on a big amount of your credit score it does show the creditors that you can handle all kinds of credit responsibly. People with no credit history or little credit history are viewed as high risk, people with different forms of credit such as credit cards, car loans, mortgages, personal loans aren’t high risk but considered responsible and more likely to be approved for a loan or revolving credit. I always recommend my clients with no credit history to begin with a secured credit card, then 6 months later turn that secured credit card into a credit card, getting your deposit reimbursed (of course as long as you’ve always made on time payments and used the secured credit card responsibly). After doing so, open a store credit card, maybe opening one at your favorite store. About a year and a half later with these credit cards, I’d recommend to move on and apply for a car loan. Of course only if your looking for a vehicle, would you get into a car loan.. If you aren’t interested in a car loan, try applying for a small personal loan. This will look good on your report when applying for different loans. Making on time payments and keeping your utilization at a low rate shows the lenders you are a responsible borrower and do not depend on the credit available.
30% of your credit score is based on what you owe, your credit utilization. Credit utilization is the amount of revolving credit you’re currently using divided by the total amount of revolving credit you have available. In other words, it’s how much you currently owe divided by your credit limit. (Google definition) Your credit usage is one of the main factors of your credit score. People that max out their credit cards or get close to their credit limit are not considered responsible borrowers to lenders. Let me tell you a credit secret, that I’m pretty sure I have shared in some older blogs… Maxing out or coming close to maxing out your credit card is NOT good for your credit utilization! I’m sure the bank consultant gave you a green light to use your entire credit limit “as long as you pay the amount back”. Wrong, the most responsible way to use your credit limit is by only using 30% or less of it. The most responsible users usually use about 6% of their credit limit and have a balance on 3 accounts equaling less than 30% of their total available credit. Your total debt-to-credit ratio would fall under the utilization. So if you have a collection or a charge-off, the debt owed on those account would fall under this factor. If you want to care about anything when it comes to your credit score, care about your credit utilization and payment history!
35% of your credit score is based on your payment history! This is the MOST important factor of your credit score. Your payment history is the most important factor because past payment history will foretell your payment history in the future to lenders. If the lender sees that you have a lot of late payments reporting, they will hesitate on approving you for the loan. One of the best ways to improve your credit score as a whole is consistently making on time payments on all accounts. So, 65% of your credit score overall is based on your credit utilization and your payment history alone! That is more than half of your credit score. While the other factors of your score are important these two can hold you back from a big chunk of credit points. If you’re building your credit from scratch these two last factors are the main factors you want to look out for and make sure you are consistent with while building your credit length and credit types.
With those tips being said, I’d like to wrap this blog up with a quote by one of the founding fathers of the United States. “Beware of little expenses; a small leak will sink a great ship”- Benjamin Franklin