When it comes to applying for a 0% balance transfer card, refinancing your student loans (or other debt) or looking to get approved for a lease or mortgage, one consideration is always at the forefront of banks, real estate agents and credit card companies… your credit score.
Everyone talks about how important your credit score is, how it should be high and not low and how it determines your ability to successfully get a mortgage, loan, apartment, credit card (and sometimes, a job)! But when it comes to actually understanding what your credit score means and what pushes it in one direction or the other, things can get complicated. So we are going to make this as easy and fun as possible.
What is a credit score?
To start – your credit score is a number and it will fall within the range of 300 to 850, with 850 being the A+ of credit scores and 300 being the F (not like a 50% F, like a 0% F). This number is supposed to determine exactly how trustworthy you are financially – how likely you are to repay your debt.
The range of super bad, bad, mediocre, good, very good scores varies, but as a general rule, over 700 is considered very good. Super bad is everything below 550. So the low, average, good range goes from 550 – 699.
The way that credit bureaus calculate your credit score depends on the specific credit bureau, making it even more difficult to fully understand how companies determine whether you are financially trustworthy. There are four major credit bureaus in the US: Equifax, Experian, TransUnion and FICO, the last of which is used by most mortgage lenders to determine whether to lend money to borrowers. Your score may vary slightly depending on the credit bureau calculating your score – some place more emphasis on certain factors over others.
These companies don’t release clear-cut explanations of the exact science behind their credit calculations but we do know a lot about the contributing factors that influence their determination of creditworthiness. Here are the main factors considered in the calculation of your credit score, in order of influence:
Payment History – this is one of the primary ones and is said to be the most influential of all of the criteria considered in determining your credit score. Payment history includes whether you paid your bills on time – if any of your accounts were in arrears or default, this would have a significant negative impact on your credit score. Payment history typically is on a rolling six month basis but skipped or missed payments (particularly for longer than 90 days) can tarnish your score for a lot longer – up to seven years!!
Total Amount Owed – another very significant factor. This takes into account utilization – the percentage of your total available credit currently in use. So if you have 10 credit cards that are all maxed out (no available credit), then you are at 100% utilization – which is NOT good. Here you want to aim for utilization under 30%. When your utilization starts creeping above 30%, your credit score can go down.
Length of Credit History – if you are a student, just turned 18, or just moved to the US, your credit score will be negatively affected by the length of your credit history. My credit history dates back to 2004 – which is positive for my credit score… but if you only have six months or a year of credit, it can have a negative effect – even if your payment history is perfection.
Types of Credit – the type of credit you have can affect your credit score. Whether you have fixed term loans or revolving credit through credit cards, this can help or hurt you – credit bureaus see diversification in credit as a positive, so if you have a mortgage, personal loan and a credit card, this could be a non-issue. If you only have credit cards, it could work against you.
New Credit – This is considered to be a minor factor (but a factor nonetheless) and relates to any new credit you have opened recently. If you have several new credit cards opened at the same time, this would negatively impact your credit score.
Credit Inquiries – this factor is what I like to call “lenders smell desperation” – and while this is a minor factor, the logic behind it is if you are asking for credit on repeat and being denied repeatedly, this could be a red flag… which could result in a lower credit score.
Found an Error?
You should look at your credit reports every few months and check that there aren’t any errors. Apparently, at least 5% of credit reports are incorrect or outdated. Errors could include being tied financially to someone you shouldn’t be (parent/child/ex-husband, ex-wife/someone with a similar name) or incorrect outstanding balances or inclusion of closed accounts. This is also a means to catching any identify theft that may have gone unnoticed (i.e., if there are credit cards open in your name that you don’t know about). You can contest these directly with the credit bureau issuing the credit score – they will investigate it for you.
If you want to check your credit score for free – click here. And stay tuned, I am putting together my top tips for improving your credit score.
Sincerely yours in harmonious fun and fiscal responsibility,