It’s no secret that credit scores can be daunting and sometimes they change when you aren’t expecting it. This guide will break down the basics of understanding your credit score and offer some ways to improve your credit habits.
Understanding your credit score:
A credit score is a three-digit number meant to essentially rank someone on how likely they are to pay their debts. Scores usually range from 300-850, with a higher score reflecting a higher statistical chance of the person repaying their debts on time. Lenders will use these scores to make credit decisions and those with higher credit scores may receive more favorable loan terms and better interest rates. It’s also important to know that you may have varying scores based on the scoring model used. For example, your FICO score may vary from your VantageScore. These two are leading credit modeling companies delivering innovative and inclusive models that report to all three of the major credit bureaus and aim to give consumers more credit access, and help lenders make better lending decisions. So, when applying for a loan it’s good practice to check which kind of score will be used. Typically mortgages and auto loans will use the FICO score while credit cards may use your VantageScore, FICO score, or a combination of other scores. Most credit cards will allow you to view your credit score for free on their mobile apps. Alternatively, you can use a free service like Credit Karma to monitor your scores from a computer or mobile phone.
What determines your FICO credit score:
- 35% of your score is derived from your payment history. Always paying on time is the best way to boost this factor. Missed and late payments will have a large impact on score, and they can be tough to get off your report.
- 30% of your score is derived from your amounts owed. This is where credit utilization comes into play. In simple terms that means using a responsible amount of credit in relation to your limits. For example, if you have a credit limit of $500 and you are using $400 you will be hurting your score as you are using way too much of your available credit. A good rule of thumb is to keep utilization under 30% and never max out your credit cards!
- 15% of your score is derived from the length of credit history. Essentially the older your accounts are the higher your score will be. Maintaining good credit habits over time is exactly what lenders want to see. The earlier you can start building strong habits the better suited you will be later in life.
- 10% of your score is derived from your credit mix. This means maintaining a mix of installment style debt (like mortgages/car payments) with revolving credit (like credit cards) is favorable. Lenders like to see that you can be responsible with both types of debt simultaneously.
- 10% of your score is derived from the addition of new credit. New hard inquiries like applying for a new credit card will temporarily ding your credit a few points, but if payments are made on time the score should rebound in just a few months.
How to improve your credit score:
- Always pay on time! Responsible payment behavior will raise your score over time.
- Use your credit cards but always keep your utilization below 30%. (If your limit is $100, only use $30 or less at a time.)
- Don’t close old accounts, keep them open to maintain credit history. Putting one small purchase a month on your oldest card is a great way to keep it active.
- Maintain good habits in both revolving and installment type debt. (Paying on time and in full for your credit cards and home/auto payments.)
- Don’t open too many new accounts in a year. A good rule of thumb is to only open one or two cards/debt accounts per year.
Your credit score is a great indicator of personal financial responsibility and improving each of these aspects will help to raise your score over time and make you more likely to qualify for favorable loans in the future. It is smart to track your score regularly as poor credit can affect your ability to buy a home, reliable transportation, and even rent an apartment.
Another important factor that lenders will consider is a person’s debt-to-income ratio, as it will be much harder to qualify for loans if you have high amounts of debt in relation to your income. It’s wise to track your debt over time, so you can ensure your debt isn’t growing disproportionately to your income as this can put you in a poor position as a potential borrower.
In conclusion, credit cards can be valuable tools to help secure yourself and earn rewards. The key to success with credit is disciplined use, as poor habits can have significant effects on your financial health and overall plan. Always paying off your balances in full and on time will help you avoid paying high interest rates and late fees. Building excellent credit will not happen overnight, as we like to say at Nepsis: Process Before Progress®. Just like all other aspects of financial health, the discipline to stick to your plan and demonstrate good credit habits over time will help to bring Clarity to your overall financial picture. If you have more questions regarding credit cards or scores, reach out to a Nepsis advisor to schedule a meeting.
Advisory Services offered through Nepsis, Inc., An SEC Registered Investment Advisor
Sources:
What Affects Your Credit Scores? – Experian – Experian
Credit Score Basics: Everything You Need to Know – Experian
https://www.nerdwallet.com/article/finance/how-many-credit-cards