Our lives seem to come down to numbers at times. And our entire financial future seems to be attached to one key number in particular: our credit score.
“Finding out your credit score for some people is like getting a colonoscopy or a root canal,” one mortgage professional in Chelsea, Massachusetts, told LifeZette. “I find myself often saying to potential homebuyers, ‘See, that wasn’t so bad!'”
A credit score is also called a FICO score. FICO was founded in 1956 by Fair, Isaac and Company (FICO), headed up by engineer William Fair and mathematician Earl Isaac. And using the five components that go into determining this score, we now have substantial clues as to how to improve it.
1.) Thirty-five percent of your total credit score is based on your payment history. Have you paid your debts regularly and on time? In this case, past performance is everything as far as underwriting goes, because it is predictive of future behavior. So if you repaid what you borrowed, did so regularly, used your credit regularly, and didn’t breach your credit limit — you have a lot going for you.
This means more than just credit cards.
It means all kinds of credit — including mortgages, car loans, installment loans, and other revolving lines of credit.
2.) Credit utilization comprises up to 30 percent of your score. FICO will examine the total amount of credit available to you across all credit sources, and how much of that credit you are using. There’s a sweet spot in here somewhere — and FICO says 7 percent seems to be it; yet also up to 20 percent is also acceptable.
If you hold onto a ton of unused credit on credit cards, this could be a very positive signal that you responsibly use your credit. Add this to your payment history and it can really help your score. On the other hand, if you have a ton of credit available and you use most of it, that’s going to work against you.
Indeed, if your debt-to-income ratio is high, then you’ll see issuers balk at granting you credit or keeping the amount offered reined in.
“Too many people charge their way through life and think nothing of it,” said the Massachusetts mortgage professional. “Then they realize the importance of good credit only after they are denied a home loan, and that’s tough.”
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Those are the two major categories, accounting for 65 percent of your score. If you’ve got these nailed down, chances are your FICO score is good. But there’s still more upside to be had, which can push you into even higher scores.
3.) Fifteen percent of your score is determined by the length of your credit history. The longer each account has been opened, the more value it has to FICO, and to credit issuers — it demonstrates stability. Credit issuers hate uncertainty. If you’ve got a card or credit line and it has been opened for a long time, and you use it regularly but sparingly, you’ll get a lot of love for your score.
By the way, using that credit regularly is also key — FICO also looks at the length of time since the credit was used.
4.) Ten percent of your score is generated from new credit. FICO breaks this down into subsets, and the theme is apparent. Open new credit accounts sparingly and responsibly. And note these points:
- In the past 6 to 12 months, how many accounts did you open? The fewer, the better.
- Were any credit inquiries made recently? The fewer, the better.
- The longer period of time that exists between credit inquiries, the better.
- Did any creditors report positive information when that account previously had negative information? That’s good.
5.) The final 10 percent is generated by credit mix. Not all credit is created equal as far as FICO is concerned. FICO likes to see that borrowers can handle a mix of credit — that means credit cards, mortgages, equity home loans, car loans, installment loans, and so on.
Looking back at this list, it becomes clear that the best way to improve your credit score is to actually use the credit that you have available, but not overuse it. Paying it back on time, every time, is also a huge element of your credit score. Paying a few days late from time to time isn’t going to do much damage, but a single 30-day late payment can crush your score by as much as 100 points.
This all goes back to one unmentioned concept that is key to credit success: keeping a household budget. Keep track of what you spend. Be aware what is being spent on credit cards and always pay in full every month if at all possible. A strong credit score gives you flexibility for your financial future, and the best possible terms on loans.