The 5 Most Important Factors About Your Credit
There are 5 major factors that influence your credit score: payment history; debt/credit ratio; age of credit; mixture of credit types; and credit inquires. Learn how much influence each factor has on your score.
1) Payment History – 35% Influence
Here are four practical steps that you can take to improve your credit score in the area of “Payments”:
- Make all of your payments on time.
- Bring your delinquent accounts current immediately. Past due balances on any account will destroy your score. Having a “30-day” late payment one month ago is worse than having a “90-day” late payment three years ago.
- Pay your bills before they go to a collection agency.
- Regularly check your credit report for accuracy and make sure that disputed bills are not negatively affecting your credit scores.
2) Debt to Credit Ratio (Balance You Owe vs. Your Available Credit)- 30% Influence
Your overall debt to credit ratio is found by dividing the total amount of debt by the total of your credit limits for your revolving lines of credit. This calculation is often the most misunderstood part of credit scoring. Creditors use your debt to credit ratio to examine your overall risk. The lower your credit utilization, the less of a risk you are to lenders. Keeping the balance you owe below 50% of your available credit limit is very important. Keeping your owed balance below 30% of your available credit limit is even better and may help you obtain a higher credit score. In other words, the lower your balance, the better.
Common Myths About How To Manage/Improve One’s Debt to Credit Ratio
- You should close all your credit accounts if you are not using them. MYTH
- You should not have credit accounts appear on your report after they have been closed. MYTH
- You should not have any open credit card accounts at all. MYTH
- You should not have high limits on your credit lines. MYTH
The credit scoring system looks at your credit utilization in two parts:
- The debt to credit ratio of each of your separate lines of credit
- The overall debt to credit ratio- the total of all of your balances owed compared to your overall credit limits
A high credit utilization in either category will lower your credit score. For this reason, it is often better to keep your credit accounts open even if you do not them. Not using all of the credit that is available to you shows that have the financial restraint and discipline to refrain from using all of the credit that has been loaned to you.
To calculate your debt to credit ratio simply divide your balance owed by your credit limit then multiply by 100. For example, if you owe $500, and your credit limit is $2,500, then you are only using 20% of your available credit line. On the other hand, if you owe $500 and your credit limit is $1,000, then you are using 50% of your available credit line. This negatively influences your credit score because the scoring system determines that you are heavily dependent on credit. Furthermore, if you you owe $1000 and your credit limit is $1,000, then you have “maxed out” your available credit and you show that you are using all of the credit that is available to you. Remember, it is not just about how much you owe. It is about how much you owe compared to what has been loaned to you.
3) Age of Credit (how long your accounts have been opened) – 15% Influence
The longer your accounts have been opened, the “older” your accounts will be. A Lengthy credit history shows your spending habits and shows the credit scoring system how you manage your credit (your payment history, how much you spend, etc.) Having accounts that have been open for a long time may increase your score, while newly opened accounts may bring your score down. Here are three suggestions to help improve your score in this area:
- Do not close your credit accounts, even if you do not use them.
- If you feel that you must close some accounts, then try to close the newest ones first.
- If you keep your accounts open and use them every once in a while, your score will improve over time.
- Think twice before jumping on that latest 0% credit card offer or opening a new credit card just to get a 10% discount at a department store.
- If you don’t have much of a credit history, and you are planning on taking out a mortgage in the future, it would probably be a good idea to establish a few open credit lines with little or no balance on them. Although newly opened accounts tend to lower your score initially, they will improve your score once they have been open for a while, somewhat active and paid off with little or no balance.
4) Mix of Credit – 10% Influence
A good mixture of credit (auto loans and leases, credit cards and mortgages) is favorable because it shows that you have experience managing different types of credit. Having too many credit cards is not a good thing.
Practical steps to improve your score in this area are:
- Having 3-5 revolving credit cards open is optimal.
- Having a mortgage, auto loan and/or a lease show a good mix, but do open new accounts just to have a good mixture. Only open new accounts as needed.
5) Inquiries - 10% Influence
Each time you apply for credit, an inquiry is added to your credit report. Your credit score calculation is affected by inquiries made within a year. Personal inquiries do not count toward your score so you can check your credit report as often as you like and that will not affect your score. The score is only affected if a potential creditor checks your credit. Potential creditors include credit card companies, auto finance companies, department stores and mortgage companies.
The reason that inquiries impact your credit score is because the scoring system assumes that if you have many recent applications for credit, then you are in some financial trouble. Too many inquiries can also mean that too many new accounts will be opened and you will be taking on a lot of debt. As a result, too man inquiries may lower your credit score.
Here are three practical steps that you can take to improve your credit score in this area:
- If looking for an auto loan or mortgage loan, shop during a two-week period rather than over a prolonged period of time. Multiple auto and mortgage inquiries are treated as only one inquiry if made within 45 days of each other.
- Do not apply for a lot of credit or open multiple credit cards at the same time.
- If you are thinking of applying for a mortgage within the next 90 days or so, it would be good to wait until after your mortgage closes before you apply for any new credit.