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Credit Scoring in a Nutshell
Many different formulas are used to calculate credit scores, but most are based on the following 5 factors.....
1. Payment History (35% impact)
2. Amounts Owed (30% impact)
3. Length of Credit History (15% impact)
4. New Credit (10% impact)
5. Types of Credit Used (10% impact)
Payment History - Make all of your payments on time. If you've fallen on tough times and have to choose between being late on a credit card payment or a mortgage payment, always make the mortgage payment on time. Lates on mortgage payments seriously damage credit scores, even more than credit card lates.
Amounts Owed - Maintain revolving account balances below 30% of the high credit limit at all times. A credit report is a snapshot assessment of a borrower’s ability to repay a debt today. Therefore, you can’t max out revolving accounts every month with the idea that “I am doing great as long as I pay my credit cards off every month”. One day per month, the creditor will report your balance to the bureaus. If you happen to max out a card one day and pay that balance off the next day, the account still showed maxed out for one day. If the creditor reports to the bureaus on the day your account was fully extended, that account will appear on your credit report as being charged to the max and negatively affect your credit scores. This is because it appears as though your ability to repay a debt is not as good as it should be. So if you have 3 cards that you faithfully pay off every month, but the creditors report at times when those cards are charged to the limit, your credit score will reflect that.
Length of Credit History - Keep accounts active and open for an extended period of time. If you are going to close some accounts because you have way too many, make sure you close up the accounts that you opened most recently. This will preserve the length of your credit history. If you close all of your older cards, you have just shortened your credit history and thus negatively affected your scores.
Types of Credit Used - A mix of auto loans, credit cards, and mortgages is positive; rather than a concentration in credit cards only. However, I wouldn't suggest acquiring new credit for the sole purpose of “satisfying” this scoring factor!
New Credit - Don’t open cards all over town just to save a few bucks here and there. We have all experienced purchasing an item and having the offer presented by the cashier to “open a credit card with us today and save 30% of this purchase”. Unless your purchase is for $10,000 and you are going to save $3,000; resist the temptation of opening up that new card. It is more likely that the hit on your credit score for opening that new card will cost you more in mortgage interest, auto loan interest, etc., than the $30 you are probably saving on that purchase. Limit frequently applying for new credit.
If you ever have questions on credit scoring as it relates to you, please feel free to contact me. I have spent over 10 years analyzing credit reports and advising clients how to improve their scores...I'm here to help!!
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