Your credit report overshadows every part of your life. Whether it’s a bank, insurance company or mortgage lender, your credit score is how they figure out whether you’re likely to miss payments or default on a loan. Now, it’s not uncommon for landlords and employers to check your credit before approving an application.
No one is exempt from the impact of their credit score.
There are five factors that determine a borrower’s credit score – payment history, debt balance, credit history, types of credit and new credit inquiries – and each factor carries a certain weight or percentage. Together, they determine a person’s credit score. Knowing which factors carry the most weight may help you the next time you’re thinking about applying for a new credit card or just paying the minimum on your balance.
Let’s take a closer look at each of the five factors:
Payment history: 35 percent
Payment history is broken down into three components: Recency, frequency and severity.
- Recency: The length of time since your last delinquent or late payment. If it’s been more than two years, you’re in the clear. If it’s been in the last 6 months, then it will have a very negative impact.
- Frequency: How often have the payments been late?
- Severity: How delinquent was the payment: 30, 60, 90, 120 days, etc? The later the payment, the more it will affect your score.
Your payment history pulls the most weight in your credit score calculation, so it’s important to stay current in this category.
Debt balance vs. high credit: 30 percent
The closer you get to your credit limit, the more negatively it impacts your credit. In general you should try to keep your credit card balance around or below 30 percent of your limit. This will have a positive impact on your score.
On the flip side, if you begin to creep above 50% of your credit limit, it will begin negatively impacting your score. If you are above 75% of your limit, it will have a very negative impact.
In other words, if your credit card limit is $5,000, charging more than $1,500 can be risky even if you pay off the balance on time. Keeping your debt low shows lenders that you’re likely able to afford monthly payments and possibly take on more expenses.
Credit history length: 15 percent
Having a longer credit history helps your score. Lenders want to see that you have a history of credit because someone with little to no credit is a riskier financial investment.
Let’s say you open 4 credit cards at the same time, and keep them open for two years. Since each of those credit cards is from a different provider, your credit history shows that you’ve been paying on each of the credit cards for two years each, giving you a sum total of 8 years of collective credit experience.
The biggest danger to your credit history is closing or opening credit accounts.
When you close a credit account (such as calling up and canceling a credit card), it completely erases your entire history of credit with that specific account. So let’s say you have two credit cards: Card A has been open for 8 years and Card B has been open for 1 year. If you decide to cancel Card A and close the account, your credit history will only show Card B and your 1 year of history. You’ve just dropped from 9 years to 1!
On the other side, opening new credit accounts can be dangerous as well. New credit accounts pop up with zero history, which is a sign of risk to lenders.
Plain and simple, don’t close or open credit accounts while trying to secure a mortgage!
Types of trades/credit: 10 percent
The credit score formula likes to see a mix of the type of debts that you’ve paid. Different types of credit or loans can impact your score more or less. A healthy mix of credit includes credit cards, home loans and auto loans. Credit consisting of only one type, such as credit card accounts, won’t help your score, so diversity is important when it comes to credit accounts.
New credit inquiries: 10 percent
If you have a lot of credit inquiries in a short time, it will lower your score because it shows you’re actively searching for more credit. This makes lenders nervous.
The credit score formula allows up to 10 inquiries in the past 12 months before any impact to your credit score. Plus, the formula recognizes that there could be several mortgage inquiries in a short period of time when someone is securing financing. The model allows a 30 day buffer for mortgage-related credit inquiries that will not impact the credit score.
Remember, when checking your own credit or when an employer does, it won’t impact your score.
If your credit score is impacted by an inquiry, the impact is only 5-15 points. It’s much more important for you to know your credit score than to fear the impact of a credit inquiry.
The largest components of your credit score consist of your payment history and amount of debt. Knowing how the items in your credit report are weighted, you’ll have a better idea of the factors impacting your score.
Do you have questions about credit scoring? Comment below or email me at firstname.lastname@example.org.
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