How to be in control of your credit score

Your credit score is the number that is used by lenders to evaluate your credit worthiness. To lenders a higher score makes you a lower risk borrower which means you will likely receive lower interest rates. Having a higher score can result in saving a lot of money throughout your lifetime. Check out our previous post which discusses the benefits of a high credit score. In this blog we will discuss what impacts your credit score. This will help you be in control of your credit score and ultimately facilitate your financial journey.

The most common credit score model used by financial institutions is known as FICO and ranges from 300 – 850. Below is an overview of what each credit score range represents to lenders.

Components of your credit score

The most important thing to remember is that we are responsible for the components that make-up our credit. Knowing these components and handling them appropriately can make all the difference in determining your credit score.

Payment history

Makes up 35% of your credit score. Making timely payments increases your credit score; while issues like charge-offs and collections can decrease your score significantly. This represents the largest part of your credit. The best thing you can do to improve your credit score is to track all of your bills due dates and make sure that you are making timely payments on your debts. Making automatic payments before your bill becomes due is the best way to ensure timely payments are made.

Credit utilization

Makes up 30% of your credit score. Credit utilization is the ratio of your credit card balances to your credit limit. Taking the total outstanding balances on your credit cards and dividing it by your total limit gives you your credit utilization. Keeping your credit utilization at 30% or less will result in a healthy credit score. Personally, I keep this amount in mind and make it my personal credit limit. For example, with a credit limit of $10,000 you should use a maximum monthly balance of $3,000. In order to keep your monthly utilization at 30% or less. Calculating this in advance helps me limit my spending and maintains my credit utilization at the recommended %.

Age of credit accounts

Makes up 15% of your credit score. This considers the average age of all of your accounts. For example if your oldest credit card has been opened for 6 years and your newest has been open for 1 year, your credit age is 3.5 years. An “older” credit age is better for your score because it shows to lenders that you have experience handling credit. Opening a new credit card can decrease the average age of your credit. Therefore, it is not recommended to open too many new accounts often. Maintaining your oldest card open can also help increase the average age of your credit. The first credit card you open should have no fees so that you can keep it open even if you stop using it.

Account types

Make up 10% of your credit score. Having multiple types of credit is another way that lenders judge your experience with credit so if you have more than one type of credit you will have a better credit score. It is better for your credit score if you have loans for different types of assets such as a car, a home or student loan. Personally, I was able to obtain a score above 750 without having multiple types of credit. So keep in mind that this is only 10% of your score and you can still manage to have a healthy score without multiple types of credit.

There are 2 types of credit accounts:

• Revolving credit – Allows borrowers to use a line of credit (an amount of money that a bank has agreed to lend you) and pay it back as it is used. One of the most common types of revolving credit are credit cards, which provide you with an available balance (credit limit) to use freely based on your needs.

• Installment credit – Allows borrowers to repay with scheduled periodic payments. Common types of installment accounts are mortgage loans, home equity loans and car loans.

Credit Inquiries

Makes 10% of your credit score. Credit inquiries occur each time you submit an application that requires a credit check. Only credit inquiries made within the last 12 months factor into your credit score; they disappear from your credit report after 24 months. If you are searching for a loan it is important to have an idea of what your credit score is in advance, so that you have an idea of what rates you will receive. You should also know that there are two types of inquiries: a soft pull and a hard pull. A soft pull does not affect your credit and can be used for certain pre-approvals. A hard pull does affect your credit score.

Personal credit inquiries are considered soft pulls. Hard-pulls occur when applying for credit a mortgage, credit card, auto loan or business loans. Always ask about the type of inquiry being made. This way you can keep track of the inquiries that are impacting your credit. One or two hard inquiries won’t hurt much; however, several within a the span of a few months can cost you many points off of your FICO score.

Tracking your credit score

Your credit score is determined by 3 U.S. credit bureaus: Equifax, Experian and TransUnion. These credit bureaus update and store your credit history and use the FICO scoring system to assign your credit score. As you can see your credit score represents many credit habits that are being tracked over time. You will only be able to control your credit score and improve it by knowing the components of your credit score and reviewing them periodically.

I keep track of my credit score on a monthly basis through mint.com. I also get an update about how I am performing in each of the factors above. There are many other banks such as CitiBank that offer similar reports. Every 12 months you can also request a copy of your credit report from each of the credit bureaus (considered a soft-pull). Staying on top of your credit score ensures that you will get better rates when borrowing money. For example, if your goal is to one day purchase a home one thing you can work on today is work on establishing a high credit score so that you will pay lower interest on your mortgage.