Undoubtedly your credit score plays a huge factor in your financial life. Acceptance or rejection of your loan application, the rate of interest offered, credit terms, even hiring or renting decisions are impacted by your credit history. As everyone knows, the higher your score the more likely you are to successfully access financing.
FICO scores range from 300 to 850. Banks and credit card companies consider scores over 760 to be excellent, and those over 700 to be good. Does this mean that if your credit score is below 700 you have no financing options? No, options exist, especially in today’s robust marketplace lending industry. Peer-to-peer loan companies utilize an alternate paradigm for measuring credit worthiness, offering financing opportunities to consumers who fail to pass the bar at the banks.
What goes into your credit score?
First of all, let’s take a look at the components that make up your credit score. According to myFico.com, credit scores are composed from five basic elements:
- Length of credit history. This category makes up 15% of your credit score.
- Payment history. Do you pay your bills on time? This makes up 35% of your credit score and offers the easiest avenue for repairing your score.
- New credit accounts. Opening new accounts is expected, but if it appears that there is a spurt of activity, your credit score can be impacted. However, this category makes up only 10% of your score, so it is not the most serious aspect and the easiest to manage.
- Credit utilization. The total net amount you owe makes up 30% of your credit score. Work to keep your balances low and pay off your debt rather than transferring it around, if at all possible.
- Credit mix. The different kinds of credit that you carry make up only 10% of your credit score. The bottom line is to avoid opening credit accounts just for the sake of having one, especially if you do not intend to use them.
Now, let’s take a look at some of the common myths about your credit score.
- You should close your old credit card accounts. The longer your history with a credit account the better it is for your credit score, assuming of course the account is in good standing. Even if you rarely use a credit card, it is better to keep it open to demonstrate a long history of being a creditor.
- Paying your monthly bills, such as cell phone, internet carrier, and utilities will boost your credit score. It will not, but consistently paying late will bring your credit score down.
- Maintaining an active balance on your credit card is better for your credit score. Actually, the best thing for your credit score is to show a history of paying the statement in full each month.
- As long as I pay all my bills on time, my credit score should be excellent. Yes and no. Your credit score is also impacted by how much of your available credit you are utilizing. You could pay all of your bills on time, but if you are using more than 30% of your available credit, your credit score will be negatively impacted. If you can keep your total net amount owed to less than 30% of your available credit and pay all your bills on time, you will have a good credit score.
- Checking your credit report will negatively impact your score. Checking your credit report, which is imperative to removing any errors, is what the industry considers a “soft inquiry.” Your annual credit report check-up will not impact your credit score, nor will a background check from a prospective employer or that pre-approved credit card offer.
- There is only one credit score. Actually, there are several different credit scores. A couple of weeks ago we talked about the various credit scores used by different financing providers. There are multiple credit scoring paradigms and multiple credit scoring companies. It is important to access information from each one but more importantly, to avoid relying on any of them to boost confidence when applying for a loan or credit card.
- Having a higher income makes for a higher credit score. Your credit score is not tied to your income. It reflects your history of paying bills on time. You could have a modest salary, but pay all your credit card accounts on time, pay off balances, have a great track record with service providers and you will have a higher credit score than someone making twice as much but holding multiple credit card accounts, with high balances, and a history of late payments and defaults.
Here is one last tidbit. All of us pay our local parking tickets and traffic citations because we don’t want our car to be booted or towed. But what about the tickets we get when we are vacationing or on business travel? It is not as simple as just ignoring them. Unpaid citations and parking tickets can be turned over to a collection agency and you may not even be aware of it. Such an action will hurt your credit score. Be sure to pay them right away.