Everybody knows that having good credit is important. However, statistics shows that in reality a pretty small percentage of population has a credit score of 750 and above. Let’s take a look at what makes up this mystical credit score that is a somewhat elusive entity but makes so much difference in everybody’s lives.
Your credit score, which is a reflection of your credit history, is made up of a number of factors. Here are the most important ones:
1. On-time payments
2. Capacity used
3. Length of credit history
4. Types of credit used
5. Past credit applications
These five factors are here listed from most to least important. So let’s briefly go over each one.
The most important factor is your history of payments and specifically your on-time payments. This is basic common sense – it’s important to make on-time payments and if you do, that will influence your credit score favorably. Vice versa, if you are often late on your payments then you credit score will suffer and it will drop. And the more late payments you make, the worse it is for your score. It can often take months and sometimes years to recover from late payments. On your credit report, these are usually classified by 30 days, 60 days, 90 days, and over 120 days late. It’s important to do everything in your power to avoid getting such hits.
Let’s take a look at the capacity used factor. This basically means the ratio between your available credit and how much credit you have used. If you have $10,000 available on credit cards then you want to keep an active balance of as low of an amount as possible. Why? If you have a $10,000 credit limit and you constantly carry a balance of $9500 then any lender that looks at your credit will see that your credit is almost fully exhausted. This does not make you a good customer for new credit lines. However, if out of the $10,000 available to you, you carry a balance of only $1000 or even $2000 then that’s only 10 to 20% of your capacity, which is a pretty good ratio. This can positively influence your credit score.
The third factor that influences your credit is the length of credit history. The longer of the credit history you can show, the better. This shows to potential lenders that you have been established as a financial consumer in the marketplace and it allows them to go back in time and see how you have performed for other lenders. If you are brand-new and you have no credit history or if it’s very short then they have little information to base credit decisions on. This makes you more of a risk factor for them to loan money to you.
The next factor is the types of credit used. It’s good to have different types of credit showing on your credit report because it shows your finances as being diversified. It’s not good to have too many open credit lines and especially credit cards but it is important to have some. In fact, even if you don’t want or need to use credit cards, it’s still good to have some open and use them anyway. If you don’t need the money then you still want to use your cards and pay them off at the end of the month. This builds up your credit history and shows potential lenders that you are responsible borrower.
The final aspect is your past credit applications. You don’t want to have too many applications showing up in your credit history, especially over a short period of time. If you do, it suggests to potential lenders that you are constantly looking for more credit which may suggest that you may have financial problems.
Hopefully this information and suggestions will make you understand your credit score better and help you make better decisions with your money. And if you do, this can help to improve your credit score which may influence all areas of your financial life.