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In my previous blog where I explain what credit is, but here I wanted to go in a little deeper on the factors affecting your credit score. These factors are so important that I’m writing an article about it; pay attention!
To clarify, your credit score is kind of like your grade in the real world; your GPA if you will. This score is a snapshot of your trustworthiness/responsibility when it comes to lending you money.
Major factors affecting your credit score include:
Payment history – 35% Very important
A consistent history of making payments show lenders and creditors how responsible you’ve been when dealing with prior debt/loans. If you’re applying for your first credit card and have been making consistent payments on your car’s loan and student loans for the last few years, it will look much more favorably than someone who has been missing payments.
It’s usually not a huge deal If you miss a deadline by a day or two, however, if you’re 30 days or more late, even just once, it could severely impact your score negatively. The specific impact would depend on the amount owed, how late you were, and perhaps how many times you’ve been late in the past.
You can expect to see an even more drastic drop in your score if your account is so late that it goes into collections.
If you know you are going to be late with a payment, call your creditor and explain the situation you’re in. They may be able to give you a grace period of a few days depending on the company. If anything, it’s best to be transparent. Creditors want their money back and some are willing to work out a payment plan with you.
Credit Usage – 30% Very important
The credit utilization rate is the ratio between how much debt you have on your account divided by your available balance. The ideal utilization ratio is less than 30%.
If you have a credit card with a $1,000 you want to make sure you only have a balance on your card of $300 or less. If your balance is $950 and you only have $1,000 on your card, you’ve almost maxed it out and appear as being irresponsible in the eyes of lenders. ESPECIALLY if you’ve maxed out several cards/lines of credit. No one will want to lend you anything if they see you spending the majority of the money you technically don’t have.
Length of credit history – 15% Somewhat important
Lenders want to see you have some history of managing credit much like employers want to know you have some experience before hiring you. Lenders want to see how much debt you’ve handled, how long you’ve had credit, how much new credit you have, and the overall credit utilization.
Keep in mind that your length of credit history is taken as an average across all your accounts. If you have an account open for 3 years and another for 1 year, they average out to 2 years.
Although this is somewhat important, it’s not something you have much control over so don’t sweat this section so much. Just be smart with the accounts you open.
Credit mix – 10% Somewhat important
This is fairly important in the eyes of lenders because it shows you can be responsible for different kinds of lines of credit. For example, you could have a credit card or two, a car loan, and some payments already made to your student loan.
Though it is fairly important, I am in no way saying you should go out and get a credit card or car loan you don’t need simply to increase your credit mix. Allow this to grow organically once you can afford to do so. Maybe start off with a credit card and student loans, then after a while, you’re able to afford to finance a car. After a few years, you save enough for a house. Maybe a little bit after that you apply for another credit card that helps you earn miles. Take it slow.
Inquiries/New Credit – 10% Less important/Somewhat important
An inquiry is something that occurs when a lender of any sort checks your credit before making a lending decision. There can be two kinds of inquiries: hard inquiry and soft inquiry. A hard inquiry occurs when a lender pulls your credit report in order to evaluate you as a potential borrower – can be a credit card company or a bank. Hard inquiries appear on your credit report and act negatively towards your score. Soft inquiries, on the other hand, occur when someone who isn’t a lender checks your credit report such as employers for a background check or checking your own score on credit monitoring sites. These do not count negatively towards your score and will not show up on your credit report.
All this meaning any time you apply for a line of credit like a credit card, it will count negatively against you. Personally speaking, the moment I get an inquiry, it affects my score about 10 points or so but that might be different for everyone.
Luckily, inquiries, for the most part, fall off around 2 years after they are reported. If you apply for a loan 2 years ago, you can most likely expect it to be removed from your credit report fairly soon if it’s not already been removed. Once it is gone, you can also expect your score to adjust slightly and hopefully increase.
Public records
This can be a little rarer depending on the situation but public records negatively affecting your credit score include bankruptcies, tax liens, and collection items. Be sure to avoid these as much as possible because they can lead to lawsuits depending on the severity.
Please note that your credit score is a big jumbled combination of all these factors that go into credit. Every bureau and scoring model does things a little different. Some bureaus might have a lower or higher score and I can’t really tell you exactly why that is.
What I can tell you though is my two cents on your credit score and how I would go about building credit. Be sure yo check those posts out!
