Building, Maintaining, & Repairing Your Credit Score
According to Geoff Williams with U.S. News, your credit score is the symbol of whether or not you are going to be able to repay a loan. For younger adults, this may give you a good idea of the concept of your credit score, but you still may not understand the significance of it. Let’s put this into perspective.
According to the National Distribution Chart of FICO credit, most of the U.S. population has a credit score of 700 or higher, with 27% of the population having a score between 750 and 799. So let’s say you miss one single payment. This can knock off more than 100 points from your credit score and land you in a very bad financial light where lending rates and fees are high, and mainstream credit is almost impossible to come by. Having a bad credit score can end up costing you tens of thousands of dollars in the long run. It highly decreases your chances of getting approved for a loan, accepted by a landlord, or approved for insurance. Once/if you are accepted or approved, you’ll be paying much higher interest rates, larger fees, more expensive insurance, and you will probably not be living in your ideal apartment or property.
But don’t let us scare you too much! Having a GOOD credit score is extremely beneficial and can be simple with a solid plan. A financially literate individual should not have any problems obtaining and maintaining a ‘good’ credit score. (As you’ve probably realized, when it comes to credit scores, the higher the better). Even if you aren’t looking to buy a house or car right now, it’s a good idea to start building & maintaining your credit early.
By now, you may be asking yourself, “How does one achieve the ever elusive, ‘good’ credit score?” The most obvious factor and biggest starting point to building your credit score is your payment history. Lenders need to know if you are going to be reliable when making monthly payments, so there are three factors that go into this. First, they monitor how recently a borrower has been in a credit problem. As time passes, the problem’s density decreases and will affect your score less and less. Second, the frequency of your late payments is closely monitored; so make sure it does not occur often. And third, creditors look at the severity of your payment history. The density of the negative effect your late payment makes on your score depends on how bad/late the payment was. For example, a payment that is 30 days late is probably not going to affect your score as much as a payment that is 60 or even 120 days late.
*Important takeaway: Make payments on time to avoid a poor history.
Additionally, as much as it may seem, your credit score is not all about punctual credit card payments. Payment history does take up 35% of your score, but there are a few other factors that go into the formula of your score. Another 30% of your score accounts for your total debt, i.e. mortgages, auto loans, large financed purchases, etc. Typically, when a borrower is frequently close to their credit spending limit, lenders see this as a warning sign. This also negatively affects your credit score, even if you consistently pay down your balance. Your debt amount is reported to the credit bureaus along with your payment history on a regular basis by your lenders.
*Important takeaway: Keep your credit balances low.
Another factor taken into account when calculating your credit score is your duration of credit; this is 15% of your total score. The credit bureau considers the age of your oldest account and the average age of all of your accounts and assigns a value based on this data. According to Fair Isaac, the average American’s oldest account has been established for about 14 years. About 25% of Americans’ oldest accounts have been established for at least 20 years. If you haven’t started already, it’s best to begin building your score as soon as possible.
*Important takeaway: Begin building, repairing, or maintaining your credit today.
Surely you or someone you know has been in a situation where they suddenly feel the need to repair credit and have turned to credit cards to do so, often applying for several within a short period of time. This ‘solution’ is a common misconception because this mistake is actually worth 10% of your total score. Don’t apply for lots of credit in a short amount of time. The bureaus look at how many accounts you’ve applied for recently, how many new accounts you’ve opened, how long it’s been since you applied for credit, and how long it’s been since you opened an account. The average American has not opened an account in 20 months.
*Important takeaway: Slow & Steady wins this race, pace yourself with credit & loan applications.
The last 10% of your score is represented by the type of credit you use. Although this factor is not extremely significant, in order to optimize your score to its fullest you need to have both revolving debts like credit cards along with installment debts like an auto loan, mortgage, or personal loan. Bankcards are typically better for your credit score than department store or other ‘finance company’ cards. These include the major credit cards, such as Visa, MasterCard, American Express, Discover, and Diner’s Club. They look better on your report than the ‘finance company’ cards because they always receive deposits, where the others usually do not. According to Fair Isaac, the average American has 13 credit accounts showing on their credit report, including 9 credit cards and 4 installment loans. Choose wisely.
Overall, building credit is not a hard task. It is a process that springs rewarding results, but does not happen overnight. Be patient, cautious, and wise.
Looking to build credit for that future home purchase? Talk to a qualified lender! Lenders know what it takes for loan approval in today's rocky credit score terrain, schedule a no obligation consultation today to get you on the right track.