Your credit score is important. It dictates how easy it is to obtain a loan for a car, house, or business acquistion. Your score is expressed as a number that ranges between 300 and 850 points. The closer you are to 850 points, the more likely you are to receive a loan and the less you’ll pay in interest. So, how is your credit score calculated and how can you improve it?
Credit score ingredients1
- Payment history, 35 percent. The most important element of your credit score is your payment history, or your record of paying your bills on time. Lenders place such a premium on this element that even one payment made later than 30 days after the due date can have a drastic effect. It can drop your score by as much as 100 points, according to FICO, the company that sets the credit score standard.
Credit Score Ingredients
- Credit card debt usage, 30 percent. Lenders like to see that you aren’t getting close to using your maximum credit card limit each month. For the best score, you should keep your monthly debt between 10 percent and 30 percent of your maximum limit. The lower the better. A great place to start is to understand your spending limits on your credit cards and keeping any balance on your cards below the 30 percent threshold.
- Credit age, 15 percent. You get a better credit score depending on how far back your credit goes. The age of your credit is the average of all your accounts, so if you open a lot of new accounts, this will shorten your credit age and start to lower your credit score.
- Account mix, 10 percent. Lenders like to see that you have a track record of paying a variety of different kinds of debts, such as credit cards, mortgages, car, and business or education loans.
- Credit inquiries, 10 percent. Each time you apply for a new credit card, a new loan, or ask for a substantial increase in your credit limits you generate a “hard inquiry” on your credit report. It’s a sign that lenders are checking into your credit history to determine your risk. While that’s not necessarily a bad thing, trying to open too many new accounts in a short period of time is seen as a red flag by lenders.
Key ideas to improve your credit
- Pay your bills on time. Ask your credit card providers or lenders to set all your due dates on the same day, and then set a reminder in your calendar. Consider using auto-pay for more important bills like credit cards and mortgage payments.
- Manage your credit card debt limits. Ask your credit issuers to increase your card line limit. You can also limit the amount of credit card debt you accumulate by paying your bill in full each month, stop using a card but not closing the account, or switching to cash as you approach your line limits.
- Build a credit history. The sooner you get started in establishing a credit history, the sooner you’ll establish a track record of payments that give lenders confidence in your ability to repay debt.
- Create variety. Manage your debt, but understand that making student loan payments on time, paying off credit card debts and other loans can present you as a quality credit risk to prospective lenders.
- Manage your credit hits. Try to limit the number of new accounts you open over a short period of time. Each hard inquiry will only impact your credit score by a few points, but each one stays on your credit report for two years.
- Know your number. Last, but not least, know your credit score. Sometimes a low score can be the result of an error in your credit history or a recent identity theft problem. You have the right to receive your credit report free once per year from each of the major credit reporting agencies. Here is the link: AnnualCreditReport.com
1 Sources: Creditcards.com; Transunion; FICO