Breaking Down Your Fico Credit Score

Vector hands holding two smartphones with credit score app on screenOh great. Another person is about to lecture you about the importance of fiscal responsibly and credit scores. Take a deep breath and relax. We’re going to cover what credit scores actually are and how to use this information to increase your own. Whether you like it or not, your credit history is of extreme importance. It is nearly impossible to be approved for a credit card, a mortgage or a decent auto loan without a solid credit score to back you up. With the right knowledge, you’ll be able to implement new behaviors and strategies to grow your credit quickly and reach the next level of financial independence. How to get a copy of your credit report and score for free.

A credit score is a number determined by a set of specific equations that ranks your credit worthiness and the risk associated with offering you credit. The most commonly used credit ranking system is FICO. Although there are various credit ranking systems, FICO is used at 90 of the top 100 largest financial institutions in the US. The equation they used it kept secret, but they do offer some details about the structure of their system. FICO breaks down each person’s credit score into five categories; payment history, the amount the person owes, the average length of credit history, the diversity of credit and the number of new credit lines.

Payment History (35 percent)

The payment history category is the most important and influential to your credit score. Your monthly payments towards your credit card and loan balances are reported by each of the three main credit bureaus. Should you miss a payment, it will be recorded on your credit report. Making consistent on time payments shows that you are a responsible spender and that you live within your means.

Amounts Owed (30 percent)

The amount you owe on your credit cards and outstanding loans is the second most important factor to improving your credit score. Say you have a total credit limit of $5,000. If you have a $1,000 balance on your credit cards, your credit utilization would be 20 percent. This is on the higher end of what FICO considers a healthy credit utilization rate. Maintaining a high amount of debt on your credit cards, or even maxing them out, shows risky and unstable behavior. Keep your credit utilization rate below 20 percent for a decent credit score, and below 10 percent for an excellent credit score.

Credit History (15 percent)

Your credit history is important, but not quite as much as the amount you owe and your payment history. For each credit card or loan you have, the amount of time you’ve had each of those credit lines will be averaged. Lenders prefer borrowers who have a history of taking and spending money at a healthy rate. Combined with a strong payment history, a long credit history shows that you’re able to manage debt responsibly. FICO recommends that you do not close your oldest credit cards because this would lower your average credit history significantly.

Types of Credit and New Credit (10 percent each)

The type of credit you have and the new credit lines you have each constitute 10 percent of your total credit score. The FICO equations look at the diversity of your credit lines. Credit cards are not the only form of credit. Diversifying your credit report with loans, brokerages or retail accounts could help to boost your credit score. However, FICO recommends not to open new credit lines unless you need them. Lastly, FICO will take into account how many new accounts you’re opening. Try to avoid applying for too many credit cards all at once, as this may lower your credit score in the short-term.

Posted on December 14, 2017 by in Credit Monitoring

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