Clarifying Credit (Part 3)

Over the last two weeks we’ve looked at several basic credit-related topics. Today we’ll take a final look at the finer details of credit by examining what factors influence credit scores and how to build good credit.

How different parts of your credit history impact your credit score

As noted in a previous post, each of the credit reporting agencies (Experian®, Equifax® and TransUnion®) takes a slightly different approach to calculating your credit score. Your score from each agency may be different, but the scores likely reflect similar creditworthiness. In addition to using their own formulas to calculate agency-specific credit scores, the agencies calculate FICO scores using a mathematical formula developed by the Fair Isaac Corporation. It is important to be familiar with the latter because it is the most widely used system in the U.S. Here are the 5 factors considered in a FICO score and the approximate weight given to each when the score is calculated:

1. Payment history (35%). Late payments and bankruptcies hurt your score, while on-time payments help it.
2. Credit utilization (30%). If you have a high credit utilization ratio (i.e., you are using most of your available credit), then your score will be lower. Carrying lower balances will increase your score.
3. Length of credit history (15%). In general, having a longer credit history will increase your score.
4. New credit (10%). Recently applying for and opening new credit accounts can lower your score. If you need to complete several applications in order to compare rates before taking out a loan, be sure to complete your rate shopping within a short period of time (e.g., 30 days). This is because inquiries within a focused period of time are often assumed to be for a single loan and will not necessarily lower your score. If the inquiries are spread out, they may lower your score because they will be seen as applications for multiple loans.
5. Additional factors (10%). A few other factors can influence your score. One of these is your credit mix. Having several types of credit accounts (credit cards, a mortgage, student loans, etc.) can increase your score.

How to increase your credit score

There is no quick way to improve your credit score. Delinquencies remain on reports for 7 years, though some bankruptcies can remain for 10 years and unpaid tax liens can remain for 15 years. Credit reports reflect your behaviors over time, so it is critical to demonstrate consistent, ongoing ability to manage credit responsibly.

• Pay bills on time. Paying bills on time is the single most important contributor to a good credit score.
• Carry low balances on your credit cards. Keeping balances low demonstrates your ability to pay off debt.
• Only apply for new credit accounts if needed. The applications count against you because they indicate to lenders that you may be taking on new debt. It’s often better to use your existing cards and then pay them off so you demonstrate your ability to manage credit responsibly.
• Don’t automatically close unused credit cards. Remember that your credit utilization ratio impacts your credit score. If you carry any debt, then decreasing your available credit will automatically increase your utilization ratio.
• Protect yourself from fraud and identify theft. Carefully guard your credit cards and your account information, use strong passwords, and check your credit reports regularly for signs of fraud.

I’ve learned some very useful information over the last couple of weeks as we’ve looked at the finer details of credit. I hope it has been beneficial to you, too! If you need additional details, you can visit my sources: Experian and Consumer Federation of America.

What have you learned from this series of posts on credit? Has anything really surprised you?