Do you know your FICO score? The Fair Isaac Corporation, or FICO, is the standard credit risk score used by 90% of the banking, credit card, mortgage, auto and retail industries. Your score affects many aspects of your financial life, from the interest rates you pay to the ability to rent an apartment, get hired for a job and more. According to MyFICO.com, credit scores range between 300 and 850, with 850 being the best.
Generally speaking, a score below 620 is considered to be a sub-prime category where borrowers will pay much higher interest rates while a score of 720 or higher typically rewards consumers with the best rates. Frequently when you see ads for low interest rates on purchases, the small disclaimer will require a 720 or 730 score or higher to get the low rates or best deals.
Many people know that paying bills on time is typically the most important and obvious factor in building and keeping a good credit score but may not know how – and why – other aspects of their financial history also play a large part in determining their scores. There may be a few surprises.
Credit Score Building Blocks
The general construction of a credit score consists of five categories, although the final impact of each depends on one’s overall financial history and how FICO places you within one of their 12 score cards models. Some financial activities may add points to your credit score and others may subtract points.
35%: Payment history – pay bills on time. A 30-day delinquency could lower your score by 60 to 110 points according to MyFICO.com.
30%: Capacity available – a ratio of your credit balances to your total available credit. The more capacity available, the better. In other words, maxed out credit is bad for your score.
15%: Length of credit – uses the average age of your credit lines factoring in your oldest established credit. Keeping your oldest revolving credit accounts open, even if mostly unused, helps to sustain a higher score.
10%: Accumulation of recent credit – new credit accounts and credit inquiries can cause you to lose points off your score and several together in a short time period is worse.
10%: Mix of installment versus revolving credit – you’re better off having more in revolving credit than installment credit and/or a good mix of credit types is preferable to just having one type.
We’ve all seen the deals from furniture, appliance and electronics stores declaring, “Pay no interest for 24 months,” or, “Same as cash” offers. One would naturally think that paying no interest by financing directly through the store makes sense, but wait. According to most experts including the Dupaco Credit Union and the Federal Trade Commission, this type of financing is generally offered through a finance company, considered to be a “lender of last resort” and as such, can hurt your score. Finance companies typically deal with sub-prime borrowers and several such purchases can have an increasingly negative impact on your score.
Other Hidden Elements of Your Score
Do When you first begin a credit history, you, of course, have a minimum length of credit time value. It takes several years for this value to reach its maximum assuming there are no recent new hard credit inquiries or credit accounts. When you add new credit, it can temporarily lower your score as part of the accumulation of new credit scoring factor.
Just one derogatory public record can severely impact your credit score with the depth of the impact depending on your existing score and your FICO scorecard category. According to Experian.com, derogatory public records can be bankruptcy filings, tax liens, and judgments or collection items and these can take from 7 ½ to 15 years to completely roll off your history.
Here’s another “gotcha.” When applying for credit, you may be wrongly advised to pay off an old medical collection bill, for example. Paying off a dormant bill can reset the timing counter from an aging derogatory obligation to a current one and could cost you significant points off your credit score simply because there was new activity on the unpaid obligation that had been aging off your score.
Have some credit? Use it wisely. A key credit score factor is how you build and use your overall credit capacity or debt utilization rate. According to an article in Bankrate.com, a utilization rate of 10% or less is highly desired. In other words, if you have $10,000 in total credit line availability, try to keep your actual total balances below $1,000. A lower utilization rate is even better.
Summary and Where to Learn More
- Pay bills on time.
- Keep the ratio of credit balances to total capacity (total credit line) low.
- Avoid “same as cash” or “pay no interest until…” store offers that are underwritten by finance companies.
- Don’t close your oldest credit lines; maintain the longest credit history timeline.
- In general, say no to new, unsolicited or unwanted offers of credit or credit cards.
- Make your ratio of installment credit to revolving credit lean more towards revolving credit and/or emphasize a mixture of credit types.
What difference does your credit score really make? The out of pocket difference between having a 530 FICO score and a 730 score could easily exceed $250,000 or more over your credit lifetime depending on your habits and utilization of credit.
Credit scoring is complex, and the more you know the better. MyFICO.com is a consumer-oriented site that explains more about how credit scores are built and maintained. Experian hosts a site devoted to educating consumers about credit score improvement, Transunion offers credit education resources online, and Equifax hosts a web-based learning center. Each resource provides helpful consumer credit information.
You frequently see offers for “free credit reports” from a variety of sources. Only one website is authorized to fill orders for the free annual credit report you are entitled to under law. Learn how to obtain your legitimate free credit report along with other useful information from the Federal Trade Commission.