Talking Credit – Give Yourself a Chance to Have a Great Future

Improving your credit score is like preparing to run a marathon; one cannot just show up the day of the event and expect to run.   When running a long race the athlete will have spent a lot of time, energy and a diet of a healthy variety of food in order to be ready.   So it is with your credit; you will need time to clean it up or improve it, energy spent keeping it up and need to understand the varieties of credit that can be used to improve or maintain your credit score.

One of the greatest assets you can have can also be one of your most bitter enemies; your credit score can either improve or detract from your quality of life.  Banks and Financial Institutions are becoming stricter than ever when it comes to your credit score.  The rate you pay for credit cards, insurance premiums, as well as auto and homes loans are all impacted by your credit score.  Building up the strength of your credit score is more than just paying your bills on time. 

 One of the most common credit scores used today is the FICO score, created by the Fair Isaac Corporation.   The credit score ranges from 350 to a high of 850, the higher the score the lower the interest rate you will pay on borrowed money, which will save you thousands of dollars over your life.  The current magic number is 720, but is currently moving up to 740.  Almost half of Americans maintain a score above 720.   As your score moves farther below 720, interest rates may begin to rise.  If you are below 580 you may not be able to take out a mortgage even if you have one currently.

Many think that the credit scoring models are an exact science unfortunately people need to gain understanding of the moving pieces associated with credit scoring as it is more of an art form.  Each credit bureau has its own proprietary formula.  While we do not know the exact formula we do know the following.

Five Credit Elements

1.   Payment History

Paying your bills on time makes up 35% of your score, we can call this your track record.   If you pay your payments a few days late and incur a late fee, this will not impact your score.  It a good rule of thumb to pay them on time or early if at all possible.  If a payment reports “late” on your credit that means the specific account is 30 days or more past its due date.  The more “lates” you have on your credit report the lower your score will go.  If a bill becomes 60, 90, 120 days late, the score quickly decreases.

If you have “late” payments currently reporting on your credit, understand the more time that passes between the last reported “late” the better.  The mortgage industry still has two major thresholds one at 12 months and the other at 24 months.   As each milestone is achieved better financing options become available to you.  Mortgage “lates” are much more serious than an auto payment or credit card payment being “late” and will have a larger impact than on your credit score.  If you are ever in a spot where you need to choose between making your mortgage payment and making your credit card payment, you should always choose to make your mortgage payment.

2.    Amount Owed

How much you owe is a 30% factor of your score.   Many think if they owe less they will have a better score.  This is not always the case; the part of your score is determined by a balancing act between your types of credit you use (mortgage, car loans and credit cards), how much you owe, and how much you have available.   Having too many credit cards could have a negative impact on your score, as well as not having more than one credit card.   Having a credit card that has a large available limit can improve your score.  This rule can also apply to home equity lines of credit for limits that are less than $35,000.  If you have lots of credit available to you use it but never maintain high balances.  The closer your balance is to approaching your limit the lower your score can go. 

 3.   Credit Type

The different types of accounts that you use make up this part of your score.  Many people do not want to use credit cards again if they had trouble in the past.  That is absolutely the wrong thing to do, you need to learn how to use credit properly and take control of your budget.

 4.   Credit Maturity

How long your individual credit accounts have been maintained is 15% of your score.   The longer you have had credit is one element, as well as how long have you had each individual account.   The longer the individual accounts have been established the stronger your score will be.  If you have old accounts that you have not used in the last 6 months the account will become inactive.  Should this occur it is not giving you the maximum points that might be available to you in this section. 

 5.   New Credit

Credit that is less than 24 months old makes up the last 10% of your score.  Doing the credit rollover game, rolling balances from one card to the next is not a good idea.  It will start to show a shallow credit report and impact the Payment History section of your score.

 Now that you know what it is that makes up your score, there are two last ideas I need to share with you.   The National Association of State Public Interest Research Groups, states that 79% of all credit reports contain errors.  It is worth your time to check your credit at least once a year.  If you find something that is wrong, take it on as your second job to clean it up.  Remember the score you have will determine what you pay over your lifetime in interest. 

 The second idea is identity theft is becoming more prevalent, I suggest you sign up for a protection plan such as www.lifelock.com.    For the limited cost it will allow to not have to worry about your credit being messed up for years to come.