DECODING YOUR CREDIT – Part II BOOST YOUR CREDIT
In this series on credit scores, we’re taking a look at understanding the basics of a credit score. As well as methods to boost your score and strategies for protecting it.
In the last segment on Decoding Your Credit -Credit Basics, we discovered the background behind the FICO Score, the elements that make up a FICO Score, and lastly, where we can find our free annual credit reports as well as your personal credit scores.
Whether you have some credit history or no history at all, you can think of your credit score a little bit like a GPA. Although you don’t have the advantage of starting out at a perfect 850, putting a ding in your score takes no time at all, while working towards a perfect score takes much more hard work and dedication. There are so many myths and rumors that swirl around the almighty FICO Score, it’s hard to know if what you are currently doing is helping or hindering your score.
We learned in the last post that there are five elements of a FICO Score and they each have different weights. This is important to know, so you can focus your efforts on the heavy hitters and not stress too much about the little things that have less of an impact on your score.
Payment History: 35%
Pay Your Bills On Time. It’s as simple as that. Set your accounts up for auto payment and go forth. Paying your bills on time makes up 35% of your credit score, so it’s important to get this one right. The general rule is that the longer the debt goes unpaid and the larger it is, the harder you get dinged. That being said, a 30-day late payment on a mortgage is going to hurt your score much more than a $500 credit card bill you forget to pay. According to FICO, one 30-day late payment can take a person with a 780 score who’s never had a late payment before and drop it by 100 points! Late payments can remain on your credit score report for up to 7 years, so mistakes from your youth can haunt you for a while.
Credit Utilization: 30%
Don’t Max Out Your Cards. You have to watch your Total Balance-to-Limit Ratio…a what-to-what ratio? Also known as, utilization, a Total-Balance-to-Limit Ratio is calculated by dividing the balance on your card by your card’s credit limit. All three of the credit bureau recommends not carrying more than a 30% utilization rate. For example, if you spend $2,500 on your credit card that has a $5,000 limit, you are sitting at a 50% utilization rate. This one can be tricky for some people, especially us military families during PCS season when we rack up mega charges on our cards to fund our moves.
Sure, you could pay in cash or with your debit, but I love those credit card points and I make them work for me. Whenever my credit card lender offers me additional credit, I take it. Sure, I don’t need a card with a $30k limit, but it totally helps my utilization rate stay low. The 30% utilization rate applies for both individual cards as well as your total charges verses limits as a whole, if you have more than one card. There’s always a catch though…while having a lot of available credit can lower your utilization rate, having too much open credit might cause some potential lenders to worry if you have the potential to over-extend yourself financially.
Pay Down Balances. When you receive your credit card statement each month, you see the balance paid. Kudos to you if you pay it off each month, you responsible credit card user, you! However, if you need a boost to your score, an occasional zero balance will give your score a lift. The only way to do this is to skip using your card for a month, or paying off the balance well before the statement comes due. This is also a sneaky one. I’ve totally used the introductory 0% APR offer on a new card before, where you only have to pay off the minimum balance, not the statement balance. I didn’t have any fees charged, but think about what my monthly balances and utilization rates must have looked like –eeeek!
Don’t Close Accounts. Closing accounts whether new or old takes away the available credit you had on your account, and that reduces your total credit utilization rate. If you close your account, you might see an initial drop in your credit score, but after a few months of good behavior, it will come back. So, if you are in the market for a big purchase like a home or a car, you may want to just leave that old account alone until after you secure your new loan.
Length of Credit History: 15%
Don’t Close OLD Accounts. The longer you’ve had credit (good), the better. The FICO formula evaluates the age of your oldest account, newest account, and the average age of all your accounts combined. Even when you close an account, it will still appear on your credit report for a while. If you really feel like you have to close an old account, don’t do it right before you try to obtain credit for a new big purchase like a home or vehicle.
Closed accounts that were paid on time remain on your report for ten years from the date the account closed, while closed accounts that had late payments remain for seven years from the date of the first delinquency.
When looking at my own credit report, it shows my oldest account as the bank account I must have opened about a week after my 18th birthday. Although I had a debit account before my 18th birthday, the account on my credit report shows the first account I opened on my own.
Credit Mix 10%
Variety is the spice of life. FICO gives you a little “credit” for having different types of credit! For example, creditors like to see a mix of installment loans (mortgage or auto loan), revolving credit (credit card or HELOC), or even open credit (a charge card or utility account). Since credit mix is such a small proportion of your credit score, don’t fret if you are missing one or several of the types of credit listed above. There’s no reason to go and open up loan just to add to your mix. Only apply for credit when you really need it.
All Credit Is Not Created Equal. Although it’s great to have a credit mix, paying off certain types of debt early won’t really affect your score. Installment debt, like a mortgage is often secured debt, as some type of asset, like home or vehicle, secures it. Credit agencies like to see it on your report, but when you finally pay off that mortgage, don’t expect your score to go up much or possibly at all. Really, the only benefit from paying off your mortgage early, its well, not having to pay a mortgage anymore. On the other hand, paying off “unsecured” credit card debt will give your score a super boost…remember the debt utilization ratio from a few paragraphs back?
New Credit 10 %
Hard v. Soft Inquiries. A credit inquiry is when you or someone else checks your credit. Credit inquiries often get a bad rap because they can sometimes lower your score. A “hard inquiry” is when you prompt someone to run your credit, usually because you are shopping for a new loan. They can lower your score by a few points and can stay on your credit report for up to two years. In contrast, a “soft inquiry” occurs when someone pulls your credit for a background check, pre-approves you for new credit (with or without your permission) or when you check your own credit report. These may or may not pop up on your credit report, but they will not affect your credit score.
“Shop” For Credit In A Limited Window. Normally, FICO would not like to see five new inquiries for new credit cards in the same week. However, with installment loans like mortgages, car loans or student debt, FICO gives you a break. They allow you to “shop around” for the best rates and it won’t ding your score for 30 days, so you can get the best rates available to you. In addition, if you make all your credit inquiries during the same timeframe, say like 30-45 days, FICO looks at it as one inquiry instead of several. The big take away here is when you are interested in getting a loan (installment loan) for a big purchase, do all your rate shopping in the same window of time, don’t stretch your research out over months.
We’ve learned that some of the elements of a credit score are easier to maintain than others. Paying your bills on time and keeping your credit utilization rate low account for a whopping 65% of your credit score. Keep doing these two things correctly and you will see your score improve.
Next week, we’ll cover some simple things you can do to protect your credit score for you and even your children! The following week will have the last post in this series on credit. We’ll have a Q&A with a trusted lender, so if you have any credit specific questions you’d like to ask, submit them to me ASAP!