Understanding your credit score and how it is determined can significantly help you when taking steps towards improving that score. Your credit score which is also known as your FICO score is calculated to predict how much of a risk you are as a borrower. FICO stands for Fair Isaac Company, which is the company that created and computes this credit score. There are other companies that also compute credit scores, however, FICO is the most trusted and most used for computing credit scores. The FICO score is able to provide lenders with a general overview of what type of history you have with credit, what type of payer you are, and what are the odds you are going to repay their money and hopefully on time.
Bottom line, the score is used to determine if you will be lent money or not and if so, at what percentage rate. The higher the credit risk, the higher the percentage rate you will be charged for credit.
The credit score is made up by the following:
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Payment History - 35% -
Total Amounts Owed - 30% -
Length of Credit History - 15% -
New Credit - 10% -
Type of Credit in Use - 10%
As seen in the list above, the bulk of the credit score is determined primarily by payment history, total amounts owed, and how long you have been managing your credit.
Payment History:
To keep your credit score high or improve your score, get into the habit of making your payments on time and stick with it. Payments made 30 days or more after the due date are considered late payments and will tell the potential lender, you have a history of paying late. Late payments reduce your score and ultimately create a negative impact. This history will generally stay on your report for at least seven years. To avoid this type of negative impact, if you find you are unable to make your payments on time, contact the lender to see what your options are. Some lenders will offer the opportunities to make alternative arrangements, dates, or even partial payments. Bottom line, do what you can to be on time, and if you find that you are not able to, do what you can to work out an alternative solution with the lender.
Keep Debt Load Under Control:
Debt to income ratio is important for controlling your debt load. Debt to income ratio is the percentage of monthly gross income that goes towards paying debts. These debts can include, but is not limited to, recurring loan payments, credit cards, rent or mortgage payments, utility expenses, taxes, insurance premiums, or anything else that is an ongoing financial obligation. Typical financing limits are usually around 28% - 36%. Up to 28% is allowed for housing expenses and up to 36% is allowed for housing expense plus recurring debt. Debt and expenses beyond 36% percent of your income is considered to be beyond acceptable limits and can affect your credit negatively.
Another area to consider when managing your credit debt load, reduce the balances on any existing credit that have high balances. For example, if you have an outstanding credit balance of $2,000 and the maximum limit for the term of that credit line is $2,500, maintaining high outstanding balances can also negatively impact your credit score.
Credit History:
Keeping accounts that are in good standing open can be to your advantage when establishing credit history. Your credit score can be impacted more negatively if you close an old account that is in good standing rather than keeping it open. Reason being, this account will show in the point system as good activity that is open or active with a zero or low balance.
Managing New Credit:
Managing new credit is also important when improving or restoring your credit score. Helpful tips to consider when applying for new credit: do not repeatedly submit multiple applications for credit, do not open accounts you do not intend to use such as opening accounts with department stores for an additional 20% off your purchase or a free $25 gift card. Opening multiple new accounts can lower your credit score because it appears in your history as is if you are constantly looking for new credit or you are irresponsibly opening new accounts.
Resources:
Free Annual Credit Report: www.annualcreditreport.com
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