The A-B-Cs of Credit Score

The A-B-Cs of Credit Score

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  1. Whether you realize it or not, credit score is an important factor in many daily consumer decisions. Things like credit card and loan acceptance, car insurance, even health insurance depend on your credit score.  Higher scores mean lower cost of credit.  Lower credit scores might even mean being turned down for a loan, and with banks tightening lending guidelines across the board your credit score is more important than ever.

    To make sure your credit score is as high as it can be, it helps to understand the factors that go into the all-illusive FICO Score.

    Fair Isaac and Company, the creator of the FICO score used by banks and credit reporting agencies across the country list five factors which determine the bulk of your score. In order of importance, they are:

    1. Payment history
    2. Amounts owed
    3. Length of credit history
    4. New credit
    5. Types of credit used

    Payment History

    Your payment history is the chronological record of payment across your credit accounts. Things like credit cards, loans, mortgages, and store charge cards are recorded and the payments you make against these debts all count toward your credit score. To say that you have a good payment history means you make required payments on-time, do not have any past-due accounts, liens, or judgments against you. Payment history is responsible for approximately 35% of your FICO score.

    Amounts Owed

    The amount of money you owe and the type of credit can affect your overall score. If you carry a balance on a credit card make sure that balance is below 50% of your maximum credit limit. For instance, if your department store credit limit is $1,000, you should not carry a balance of more than $500.

    Length of Credit History

    The longer your credit history the better. This shows you have a track record of responsible borrowing and credit use. Using your credit accounts on a regular basis will also increase your credit score.  By charging and paying off your balances each month, your credit report will show a good credit history and a higher credit score.

    New Credit

    Every time you apply for credit an inquiry is added to your credit file.  Inquiries vary with the type of credit account. A loan inquiry will be treated differently than an inquiry for consumer credit. In general, too many inquiries will cause your credit score to drop. Inquiries drop off your report after a period of time. To make sure you don’t rack up too many at once, spread out your credit applications and try to not apply for credit cards or loans in a short period of time.

    Types of Credit Used

    Installment loans (mortgages, lines of credit) are treated differently then revolving credit (credit cards and store charge cards). Paying off an installment loan will add points to your score, as will adding a new installment loan and keeping it paid, on-time.  Revolving credit will keep your score high as long as the account is paid on time, but closing your revolving lines of credit can hurt your score rather than help it.  Referring to length of credit history, your better off keeping a revolving line of credit account open and not using it or and charging minimal amounts on it, than cancelling the account because of inactivity.

    How to Improve Your Credit Score Now

    To raise your credit score use these factors to your advantage. Knowing that payment history is the largest variable, you should first make sure all your credit accounts are current and paid as agreed, on-time. After doing so, write to your creditor and ask them to send you a letter stating you have brought your account current and you are now paying as-agreed. You can then fax that letter to the credit reporting agencies and make sure they update the file accordingly.  In most cases, the agency has 30 days to update the file. Be sure to check back with them in a month and make sure the changes were made.

    The next change you should make is to adjust the amount of money you owe. Create a budget and make sure you are living within your means.  When expenses exceed your income you are likely living on credit and your score will suffer.  Start by paying off the revolving accounts with the highest interest rate first. Also, on the accounts where you maintain a balance, make sure the outstanding amount owed is less than 50% of your maximum credit limit.

    For most people, your credit score is a reflection of how you use credit cards, as the debt most Americans carry is solely credit card debt.  To keep your credit score high, use credit cards wisely, and remember to check your credit often to make sure errors and inconsistencies are immediately removed.

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