A new year brings resolutions for many. Whether you set your own resolutions or not, most would agree there are some aspects of their life they’d like to change. One area that often is the focus for resolutions is personal finances.
An easy way to take control over and hopefully improve your financial well-being is to better understand your credit report.
Your credit report is a compilation of your credit history. It is a record of how you’ve used money in the past including credit cards, loans, and bill payment. If this were school, your credit report would be grade except instead of a grade for each course, it’s a cumulative score for your recent history (about 7 to 10 years). And instead of a letter grade you receive a three-digit credit score.
The current model used to score your credit was created by Fair Isaac Corporations (FICO) and is used by financial institutions. There are other systems out there, but FICO is by far the most common. Your score is determined by five main factors.
The single biggest factor influencing your score is self-explanatory. Payment history gives your potential creditors a look at how you handle debt. How have you paid your bills in the past? Do you have a history of non-payment, or late-payment? Has your account gone to collections?
Only payments 30 days past due can be legally reported to the credit bureaus. And the longer you go without paying, the worse it is for your score.
But the best way to keep this factor positive is to pay at least the minimum, on time, and on all your accounts. On average it takes about six months of positive payment history to raise this number.
This factor is not as straight-forward as it sounds. While how much debt you carry in total is important, it is not as significant as your credit utilization. Simply put, how much debt do you have in relation to how much your limits will allow? This ratio is factored not on a per-debt basis, but as a whole. However, account types are not equal. Credit cards are weighted more heavily in the negative than an auto or home loan.
Keep track of every credit card you have and what the limits are and avoid hitting your credit limit to keep this factor in check. It is also recommended to keep unused accounts open instead of closing them—just make sure not to use the extra card.
The most common rejection most new applicants might receive is no or not enough credit history. With your finances, age is more than a number. Your credit report must have at least one account that’s been active for at least six months to even generate a score.
The age of your oldest account is just a portion of this factor. The length of time since your newest account was opened and the average age of all your accounts is also factored into the length of your credit history.
Finally, your usage will be considered. Being active with your credit is helpful. Old accounts that are inactive may not have much of an impact on your score.
Credit age and real age have some correlation. The younger you are, the less time you’ve had to establish a significant credit history. But you can still achieve a relatively high score at a young age. Keep your payment history and level of debt in good standing. Just don’t expect an 800 in the first years of credit usage.
There are three types of credit that will appear on your credit report: revolving credit, installment credit, and open credit. Having a mix of these types of credit and paying them off as agreed is best. Negative history in revolving credit will count more heavily against your score in this area.
Revolving credit is a line of credit you can borrow from but has a limit. This is your credit card and home equity lines of credit (HELOCs.) You are charged monthly payments and interest for any balances carried forward.
Installment credit is a loan with a set amount of money due on a repayment schedule. This could be a mortgage or loan.
Open credit is fairly rare. It refers to accounts that you can borrow from up to a maximum limit but must be paid back in full every month. An American Express charge card is a common one.
Opening a new credit card could hurt your overall credit score. A new credit card (unless it’s your first) lowers your average credit age.
Every time you apply for a credit card or loan a “hard inquiry” appears on your credit report—even if you aren’t approved or do not open an account.
Hard inquires remain on your credit report for about two years. However if you are shopping for a mortgage and several hard inquires appear in a short window of time, this is treated as one inquiry.
Credit bureaus like Equifax, Experian, and TransUnion use these factors to compile your score. They then sell this information to help businesses, like creditors and insurers, make decisions regarding you.
Every creditor has its own range of acceptable risk in a credit score, but the average is: below 579 is poor, 580 to 669 is fair, 736 to 670 is good, 799 to 740 is very good, and anything above 800 is excellent.
In our next article in this series, we’ll talk about how to get and read your credit report, how often you should check it, and what you should do with it.