Financial planning is riddled with numbers. Of all of the numbers we talk about in this business, few impact an individual’s financial situation more than their credit score. If you have an upcoming transition in your life such as changing jobs, applying for new debt, or moving to a new home, your credit information will have a direct impact on you. Your credit score drives the terms and interest rates you get on loans, insurance rates, and even cell phone contracts. Employers often use your credit information as part of the hiring process.
There are multiple companies out there that produce a credit score; however the FICO score is by far the most popular. In today’s post we’ll take a look at the key components of your FICO credit score, and how you can manage it to get the highest score possible.
According to Fair Isaac, your credit score is made up of the following components.
- Payment History (35%) – This is the most important factor of your credit score. Lenders want to see a track record of you consistently making payments on time. One late payment won’t kill you, but establishing that you can responsibly manage your bills is critical.
- Amounts Owed (30%) – There are many factors that play in to this component of the score. The total amount of credit you have been extended, and the total amount you owe on those accounts is the most important factor. If your total loan (and line of credit) balances are close to the max amount or initial amount owed, this causes concern and drives down your score. Strive for a low credit utilization ratio; something less than 30% is preferred. Having a variety of types of credit, and a low credit utilization ratio helps push up this piece of the score.
- Length of Credit History (15%) – This component of the score is looking at the length of credit history, which goes along with the payment history. They look at the “age” of credit accounts that you have, as well as an average age of all of your accounts. They also consider account usage and the number of accounts that have been established recently. The longer your credit history, the better.
- Types of Credit Used (10%) – This component of the credit score is the mix of credit types you have. This is a bit different for everyone, and there is no “magic mix” of credit. However, in general, you want to have a diverse mix of credit types, including installment loans (e.g. mortgage, auto, student loan), revolving lines (credit cards), and open accounts (utility bills). Drivers of a good score here are having a mortgage, not too many credit cards, and using other good types of installment loans such as a student loan or auto loan.
- New Credit (10%) – The final component of the credit score looks at the amount of credit you have recently applied for and acquired. This is where the amount of recent inquiries and new loans come into play. If you have a lot of activity in the recent past, that can ding your score. If you are shopping for a mortgage or auto loan, don’t worry about multiple inquiries, assuming you do your shopping in a short amount of time (generally two weeks). Multiple inquiries to the same type of lender over a short amount of time count as only one inquiry on your credit report for these types of loans.
Understanding and proactively managing your credit is an important piece of your financial life. This can help ensure that you get the best terms on loans, get more discounts when buying insurance, and even make you look better to potential employers. If you have an upcoming transition, your credit information and score will likely have an impact on one of the key aspects of the change. To find out more about managing your credit, check out these two websites, which were used as sources for this post:
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