Understanding Your Credit Score

Photo credit: GotCredit / Foter.com / CC BY

There is a number out there “in the cloud” that tells the world about your financial reputation. Your credit report and score. Theoretically, you have to give permission for someone to look at it, but many view it. So what makes up this score? Many ask this question.

Here are five factors that can affect your credit score:

  1. Payment History. Payment history accounts for 35% of your score. Paying your bills on time can mean the difference between an exceptional credit score and an average one. You can pay your bills online or by mail, but don’t just throw bills in a stack never to be seen again. Find the due date. And pay your bills on time, making certain you give ample time for mail delivery (at least four days).
  1. Credit Utilization. This accounts for 30% of your score. Credit utilization means you have been approved to borrow a certain amount, but have not borrowed that amount. You get a higher credit score for a larger available line of credit, but a lower credit score if you keep an outstanding balance on your card. Credit bureaus perceive that as long as you have the ability to borrow, you can pay your bills. But if you max out your lines of credit, you have expended your borrowing capacity. And your score is lowered.
  1. Length of Credit History. This accounts for 15% of your score. Credit bureaus like you to keep the same credit cards for a long time. In fact, if you have kept your card(s) over seven years, they view it favorably. If you have a credit history, make sure to hold on to your account(s).
  1. Credit Inquiries and New Debt. This accounts for 10% of your score. When you apply for a loan or a credit card, the lender checks with credit bureaus to get your credit score. That inquiry lowers your score, at least for a season. Then, if you decide to get the credit card, the new debt will lower your score even more. Try to avoid the new debt scenario all together.
  2. Type of Debt. This accounts for 10% of your score. There are basically two types of debt: installment and revolving. Installment debt is borrowing a specific amount and making payments until the loan is paid off (i.e. home loan). Revolving debt is the ability to borrow up to a certain amount; as long as you are below the limit, you can borrow whenever you want (i.e. credit card). Installment debt is favored over revolving debt.

I strongly recommend getting your free credit report each year. I also recommend you pay the additional fee, usually about $15, to get your credit score with the report. If anything, use this to ensure there are no fraudulent accounts opening up under your name. You will be given a guide to help understand your credit score, and how you can improve it.

Of course, my hope is that the scenarios where you need a credit score are rare for you. Those whose finances are healthy are those who tend to have a high credit scores. However, they are also the ones who need it the least.

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