Understanding and Improving Your Personal Credit Score
Your personal credit score plays a key role in nearly every financial decision you make. Often referred to as your "FICO score, it’s essential to understand what goes into your credit score and how to improve it. Here, we’ll break down the components that impact your score and outline strategies to help you achieve a higher one.
What is a FICO Score?
The term “FICO” stands for the Fair Isaac Corporation score. It’s a measure used by lenders to determine your overall creditworthiness (i.e. if you qualify for a loan or not) and also helps indicate how well you’re likely to manage credit in the future. FICO scores range from 300 to 850, with higher scores reflecting better credit. A strong score can help you qualify for credit and at better terms.
How to Check Your Credit Score
You’re entitled to a free credit report from each of the three major credit reporting agencies—Equifax, Experian, and TransUnion—once per year. I strongly recommend making a habit to pull your report annually. You are responsible for reviewing and correcting any errors, which can affect your credit score if left unaddressed.
Breaking Down the Five Components of Your Credit Score
Your credit score is calculated based on five key factors. Let’s take a closer look at each and explore strategies to improve them.
1. Payment History
- Definition: Payment history is the most important factor in your credit score, reflecting your track record of paying bills on time.
- Strategy: Always pay your bills on time, aiming to pay off balances in full. Consider setting up automatic payments to avoid missing due dates. Late payments can stay on your credit report and impact your score for longer than you may think:
- 30 days late: Can affect your score for up to 9 months.
- 60 days late: Can impact your score for up to 3 years.
- 90 days late: May linger on your report for up to 7 years.
2. Amounts Owed
- Definition: This one answers the question: how much money do you owe to lenders? One commonly used metric is your credit utilization which represents the total debt you owe compared to your available credit. For example, if you owe $1,500 and your credit line is $20,000, your credit utilization rate is 8% ($1,500 / $20,000).
- Strategy: Aim to keep your credit utilization under 30%, and avoid exceeding 80%. A high credit utilization indicates over-reliance on credit and can negatively impact your score.
3. Length of Credit History
- Definition: This factor considers the age of your credit accounts.
- Strategy: Keep credit lines open as long as possible, even if you don’t use them regularly. Closing accounts can shorten your credit history. So, consider keeping accounts open and using them periodically, paying off any balances monthly and in full to demonstrate responsible use over time.
4. Types of Credit
- Definition: Lenders evaluate the types of credit accounts you hold, such as installment loans (e.g., mortgages, car loans) versus revolving credit (e.g., credit cards). In this way, your Amazon credit card is looked at differently than your car loan or mortgage. One reason for this is because the asset (i.e. your car or house) can be sold in the event of default to repay any creditors.
- Strategy: Be careful and selective when opening new lines of consumer credit. It may be tempting to get the 10% discount when you check out. However, in the long term, know that this is not doing you too many favors.
5. New Credit
- Definition: Each time you apply for new credit, an inquiry is recorded on your report, which can lower your score.
- Strategy: Similar to 4, consider every offer carefully before opening new credit. Research each option to understand how it will affect your credit over time, and only open new accounts when absolutely necessary.
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