What Factors Effect Your Credit Score?
I find it strange that the credit industry shrouds the infamous personal credit score in such mystery. It isn't taught or explicitly intuitive what factors effect your credit score. They certainly aren't explained to you whenever you open a new line of credit, such as a card, an auto loan, a student loan, or anything else that requires a check.
Even I don't know exactly how a credit score is calculated. I'd be curious to know if any of our readers are aware of a sophisticated software algorithm that could take your credit history and spit out a number that matches your FICO and Equifax credit scores with any degree of accuracy. Your credit score is a number between 450 and 850 that gives potential lenders an idea of how risky it is to lend you money. If you have a low score, you probably have some bad marks on your record. Broken lease/ purchase agreements on vehicles, late payments on credit cards, and defaulting on other debts, as well as bankruptcy, can negatively effect your credit score for years (bankruptcy being the longest lasting, at ten or seven years depending on the chapter filed). Most things stay on your record for two years.
That being said, what I do know, and what I would like to explain to our readers, is exactly what factors effect credit score, and what can be done to improve those areas.
Credit Utilization/ Usage:
a. Your credit score is impacted by what percentage you utilize of how much money is available to you. For simplicity, let's say you have two cards, each with a credit limit of $5,000. Your total credit limit is $10,000. To achieve the "best" impact on your score, you should always make sure that no more than 30% of your credit is utilized at any given statement end (it is fine to exceed the 30% threshold so long as it is paid back below that by the time you receive your next statement communication).
b. This area of your score can be improved by making sure you never use more than 30% of your credit. Although this applies as a blanket effect, and if you have $3000 on one card and zero on the other, you are still in the green, I would err on the side of caution on this one and not use any specific card more than 30% of its own capacity. I don't know if that has an effect or not, but it very well make the difference between those of us with a score of 800+ and those plebs still in the high 700s (pff, I don't have a score in the 800s. See "Age" as a factor later on).
Payment History/ Percentage of On Time Payments
a. When you make a payment on or before the due date each month, it looks good on your credit report.
b. Generally, most credit cards have a 30 day grace period before they make a report that you have missed a payment. This means that if you happen to miss the cut off date for making a payment when a card or loan is due, you may be forced to pay a late fee, but the late payment will not be on your record. If you exceed the 30 day period, however, you may have a larger late fee as well as a black mark on your record for 2 years. I missed a payment in college accidentally on my card with a limit of $600. It bit me when I tried applying for a loan a few years later. The mark dropped off my record about 2 months after I made the credit inquiry, and my score shot up a good 30-40 points as I recall.
Don't assume that your loan agency will be as generous as those that allow a 30 day grace period. Always pay your bills on or before the due date to be sure.
In the event that you do miss a payment (which I had done before from time to time before I automated my payments) give your credit agency a call and ask them to waive the late fee. I have had great success with calling them up and usually they are fine with letting it slide if you have been a customer for a while and don't have any other glaring derogatory marks.
Average Age of Credit:
a. How old your credit history is has an effect on your score as well. It may be difficult to get a score in the high 700s in your early, mid, or even late 20s because your credit simply isn't that old, even if you have superb aspects in all other areas of credit. Perhaps you got a credit card after high school, another during college, another out of college, and an auto loan after graduation. Every time you open a new account, your average age of credit drops an amount proportional to how long your accounts have been open, divided by the total number of accounts you have.
b. This can be improved by being patient, plain and simple. As you get older, your credit age will increase and you will be seen as a more trustworthy candidate for lending. This one ties in with the next one in a bit of a catch 22, so read on.
Total Number of Credit Accounts:
Lenders like to see that you have some mixed lines of credit that are both open and closed. An example of an open account would be a credit card in your wallet, or an ongoing auto payment/ lease. A closed account would be a car payment that was paid off, a lease that was completed, or a mortgage that was paid off. Having a larger number of closed accounts and open accounts can look good or bad, in conjunction with your age of credit. Maintaining a healthy balance here is critical, as lenders do not want to see a multitude of closed accounts and no open ones, as well as them not wanting to see a bunch of open accounts and no closed ones. There is some subtlety here so I would do a littler personal analysis and see if opening another line of credit or obtaining an auto loan would help or hurt your credit score. This figure is greatly individually dependent on how your financial life has been lived so far.
Credit Inquiries within the last 2 years:
When you apply for new lines of credit regularly, it can negatively affect your score. If you have a dozen credit inquiries on your record and don't have open accounts to back them up, it looks like you're a credit deadbeat. You apply and don't follow through and actually obtain financing or get approval for the card. I think a good rule of thumb would be to stay below 3 credit inquiries within a two year period, and less if possible. Again, sometimes life happens and this number will raise.
The good news about all of this is that unless you've filed for bankruptcy, you generally get a clean slate after two years of reliable payment history and no derogatory marks. This means you can royally screw your credit and for the most part be fine in a couple years as long as you get on track and stay there. The final factor I will add to this list is derogatory marks. These would be late payments, defaulted loans, repossessions, bankruptcies, etc. They each count as a separate incident, and they should be avoided at all costs because even a single one can be detrimental to your score. It can take a long time to get an 800+ credit score, and a derogatory mark can make it tank like a stone in the ocean. Do yourself a favor and don't get a derogatory mark. If you already have one (or several) make sure that there is nothing in your power that can mitigate its effect, and be diligent about not getting more for two years. That can be a long time if you're looking to make a large purchase on credit in the near future, but we make the beds we sleep in.