Your credit score is one of the most important numbers in your financial life (probably #2 after your Social Security Number, which is required for just about everything!). Because credit scores are so important in today’s society, it’s essential to understand your credit score – why it is important, how it is comprised, and how you can improve it. So let’s take a look at all of these and go from there.
Understanding Your Credit Score
The importance of your credit score. Many people believe your credit score only matters if you need to borrow money. That was true once upon a time, but that is no longer the case. In fact, borrowing money is only one way your credit score can be used. For example, many people look at credit scores as a mark of how trustworthy people can be with money or high security items, which is why it is so important to have a good credit score.
For example, many employers use your credit score when screening job applications. Your security clearance can be affected by your credit score. Landlords often screen the credit scores of rental applicants before allowing them to sign a lease, and cell phone companies may not provide a line to people with poor credit. Of course, your credit score is also used by lenders to gauge how likely you are to repay your loan – the higher your score the more likely you are to get a loan at a favorable rate.
How your credit score is determined
Most people refer to the FICO credit score when they talk about credit scores. This is the credit score most commonly used by lenders, but there are several different credit scores available. In this example we will examine how a FICO credit score is determined. We can then use this information to understand how to improve your credit score.
Understanding the components of your credit score:
- 35% – Payment history.
- 30% – Amounts owed.
- 15% – Length of credit history.
- 10% – New credit.
- 10% – Types of credit used.
How to improve your credit score
Most important aspect of your credit score – on time payments. To improve your credit score you simply need to work on the above areas, noting which items are weighted the most heavily. For example, making on time payments is more than 1/3 of your credit score. If you have been late on your credit score, then making consistent on time payments will increase your credit score. Additionally, more recent credit history will be more heavily weighted than older history. So negative marks on your credit count less against you as more time goes by, and recent positive actions are more heavily weighted in your favor.
Next up – credit utilization. Another quick way to improve your credit score is to pay down more of your debt. This is often referenced in your credit utilization, which is the amount of credit you are using compared to the amount of credit you have available. For example, having $5,000 in credit card debt on a card with a $10,000 limit is better than owing $5,000 on a card with a $5,000 limit. Sometimes just increasing your credit limits can have a minor affect on your credit score, however, it is generally better to pay debt off as that is virtually guaranteed to improve your score.
Making on time payments and the amount of money you owe make up almost 2/3 of your credit score, so these are the areas in which to focus. But they aren’t the only ways to improve your credit score.
Credit history and new lines of credit. The length of your credit history plays a role – the longer you have an established credit account open, the better. So sometimes it is better to leave a line of credit open instead of closing it because it may help your credit score. Conversely, opening a lot of new lines of credit can hurt your score because it decrease your average age of credit (15% of your score) and it counts as new credit (10% of your score). So if you need to open a new line of credit, make sure to wait awhile before opening another line of credit.
Type of credit. Finally, the types of credit are important to your score. Not all types of credit are created equally. In this instance, installment loans are often the best type of credit – things such as a mortgage or a car loan. next on the list is unsecured credit, which would be a loan such as a credit card balance or an unsecured cash loan. But even these aren’t created equally – department store credit cards, lines of credit through a store, and payday loans can have a negative impact on your credit score – and they often come attached with higher interest rates, which is another incentive to avoid them!
Get a free copy of your credit score! You can get your credit score for free from companies such as GoFreeCredit.com, which offers a credit monitoring service. Simply sign up for a free 7 day trial, get your credit score and cancel your membership before your free trial ends if you do not want to keep the service.
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