Credit Score- What is it and How to Improve It
Everyone talks about a good credit score and how important it is to have a high score.
But what is a credit score and what can we do to improve this magic three-digit number?
Although there are many credit-scoring models, the goal of these formulas is to figure out your credit risk — the likelihood of you paying your bill on time, or whether you'll pay your debts as agreed. The exact formulas are kept secret, but whether you’re looking at a FICO® or VantageScore® credit score, they are based on the same information: the data in your credit reports. The software uses advanced algorithms to comb your credit history for signs of good (and bad) credit management habits.
If you are working on improving or maintaining your score, here are the five factors that affect the score.
Payment history - paying your bills and other obligations on time every month is the most important factor (even 35% of your score). Being late by 30 days can dent your score, so remember, the later you pay, the greater the damage. It might be a good idea to set an autopay or a calendar reminder to help you stay on the right track.
Credit usage (credit utilization) - it is the second important factor, about 30% of the score. It is simply the percentage of the amount of your credit limit that you use. Experts recommend using no more than 30% of your available credit. To help with that, try setting up balance alerts or making extra payments during the month. The good news is, once your total balance goes down, your credit score will benefit from that.
Length of credit history - the longer the better! Opening new accounts could lower the average age of your accounts. Unless you have a compelling reason to close the account, keep your old credit line open. If you choose to close an account (with no payments left) it will remain on your credit score report for 10 years.
Credit mix and types - if you can successfully manage multiple debts and different credit types, that means you have experience and it will benefit your credit score. It is a minor factor so you probably shouldn’t take out a loan just for that reason.
Recent credit - when you apply for a new line of credit, lenders may view your credit reports and scores. Credit inquiries can stay in your record for up to two years. Soft inquiries (checking your score, and some credit card prequalification) don’t hurt your score. Hard inquiries, on the other hand, can change your score even if you don’t get approved (up to 5 points). But do not be afraid to shop for a mortgage, car, or student loan. Credit scoring models see rate shopping (finding the best rates and terms on installment loans) as positive behavior and add them together if done in a short period (about 14 days). Remember that this rule doesn’t apply to credit cards. Each inquiry is treated separately and can have a significant impact if you apply for a few cards in a short time.
Factors that don’t affect your credit score:
checking your score
rent and utility payments
income and bank balances
Knowing your credit score and ways to improve it is key to a successful financial future. If your goal is to improve your score, try to focus on the two most important factors- payment history and credit utilization, as these two have the highest impact on your score.