Remember the influence your grade point average (GPA) had in high school? If you’re finished pursuing your education, you’re probably relieved that having a number attached to your identity is in your past.
But, actually, they’re not.
There’s a number that reflects your financial health, and it’s your credit score.
Your credit score is used by banks and lenders to help them decide if you should be approved to borrow, how much they’ll lend you and how much you’ll pay in interest. Whether that’s applying for a loan or taking out a mortgage, your credit score is a key player in how good you look on paper.
There are also other scenarios where your credit score becomes important. Trying to rent an apartment? Your landlord may run a credit check to verify you can handle the monthly rent. Looking for a new job? Some employers look at a candidate’s credit score to gauge their responsibility level.
Bottom line: even if you aren’t on the market to borrow, you should always be aware of your credit score.
Credit score mathematics
When it comes to finance, it’s easy to throw your hands up in the air and insist you’ll never understand how numbers, like credit score, are generated. But, you don’t have to be a mathematician or numbers nerd to grasp the formula behind that three-digit number. FICO breaks down your credit score into five simple factors:
- Payment history (35%): Repayment of debt is the single most important factor for your credit score. This includes revolving accounts like credit cards, as well as installment accounts like a mortgage or personal loan. The amount of weight placed on each type of account is based on the total borrowed. For example, a late mortgage payment is more damaging than one on a low limit credit card. Make payments in full, on-time, every time.
- Credit utilization (30%): This is the percentage of credit available to you that you actually use. A credit utilization ratio below 30% is most preferred by banks and lenders. If you tend to inch close to your credit limits on revolving accounts, that ratio quickly increases and you appear less desirable a candidate for borrowing.
To keep credit utilization in check, maintain low credit card balances—it’s that simple.
- Length of credit history (15%): This is the amount of time each line of credit has been open and how long since the last transaction. We all have to start somewhere, so what about someone new to credit? Once your first borrowing account shows six months of payment history, you’ll have your first credit score. Nurture your credit from the time it’s “born” and use best practices to keep it strong.
- Credit mix (10%): The mix of credit you repay makes up a tenth of your score. The variety of debt you owe shows banks and lenders how capable you are of handling different types of credit. For example, a person with multiple credit cards looks less attractive than a person with a mortgage, auto loan, credit card and other installment accounts.
For a healthy mix of credit maintain both revolving and installment accounts.
- New credit (10%): The number of accounts that are new versus those that are well-established will factor in as another tenth of your credit score. It doesn’t matter if you’re a beginner borrower or a seasoned one, the best piece of advice is not to open too many accounts at the same time. This signifies to lenders that you’re in financial trouble. Although the hit to your score is small, newer accounts lower your average account age.
Be smart about how you shop for credit and only do so when it makes financial sense for you.
Financial success starts with your credit score
Understanding what goes into your score is one of the most important elements to achieving financial freedom. If you’ve never checked your credit score, or it’s been a while, we encourage you to use one of the free, online resources like your Free Credit Score. If you need help establishing and improving your credit, or guidance charting your path, RiverTrace is here to help. Contact us today at (804) 266-2767.