Credit Score Basics
What is a Credit Score?
The majority of people understand the basics, like failing to make a payment will make your score go down, but there are a number of complexities that trip up the average consumer. If you pay your debts on time, don’t carry too much debt on any one card, don’t close older accounts unless absolutely necessary and only apply for new credit when you have to you will generally be in good shape. However, it is important to keep yourself informed so you can maintain a credit score that accurately reflects your consumer status.
Lenders use your credit report in order to judge your reliability as a loan candidate. Your credit report indicates your ability to handle debt responsibly and will help banks decide if you are a desirable loan customer. A high credit score can help you lock in low APR rates or secure special deals on loans. A bad credit report may prevent you from securing loans and can damage your ability to buy a car, open a credit card or rent a home. A history of inability to manage your credit successfully will make lenders uncomfortable about trusting you with additional funds in the future.
You are entitled to a free copy of your credit report once a year, an offer you should take advantage of. When you do receive your credit report, check to ensure the figures are accurate and act quickly correct any mistakes. This may include any clerical errors, identity theft issues or incorrect information. If your credit score is low, you should begin working on a financial rehabilitation plan, either on your own or with a certified debt councilor, to begin correcting your bad debt habits.
The Credit Score Breakdown
What Makes Up a Credit Score?
Your credit score is determined by an algorithm developed by the Fair Issue Corporation (hence its other name of FICO score). Since its inception, three corporations, called “credit bureaus” specialize in collecting and reporting on financial histories. Those three companies are Equifax, Experian and TransUnion. While, the exact formula used to calculate your credit score is a tightly guarded industry secret, these companies provide general guidelines about financial behavior that can affect your credit score.
Payment HistoryThirty-five percent of your credit score is made up by your payment history. This includes late payments, collections, and even bankruptcies and tax liens. Each type of account will stay on your credit report a specified period of time and each type of derogatory will hurt your score differently. Credit Strategies does much of their work here to work to remove accounts that are not 100% accurate OR not 100% verifiable. Our removal rate is around 70%.
Debt RatioYour debt ratio is the amount of revolving credit (i.e. credit cards) you owe in relation to the amount of credit you have available. So, for instance, if your credit limit is $10,000 and your current balance is $2,000, your debt ratio would be 20%. While, ideally, you would have you debt ratio at 0%, we usually recommend you are at least at 30% or lower.
Length of CreditYour length of credit is how long you have had credit. At face value, this seems like something you couldn't really do anything to fix. However, there are ways you can hurt yourself here. If you close out your older cards, even if they have higher interest rates, it will hurt your score. The credit scoring model has no memory or credit cards you close, so if you close out that fifteen year old card you will get no credit for it!
Types of CreditTypes of credit include revolving, installment and mortgage loans. By having different kinds of credit open, you show creditors that you are responsible and able to handle different kinds of responsibilities.