Whether you’re considering applying for a home loan or just want to manage your finances more effectively, it is a good idea to understand credit reports and the five factors that go into your credit score.
First, what is a credit report? Credit reports are maintained by three nationwide credit reporting companies (Equifax, Experian, and TransUnion) and contain information about your credit accounts, including outstanding balances and types of accounts; information on credit inquiries, which occur when you seek credit, such as a new charge card account; and public records information. This includes information regarding collections if, for example, you’ve been delinquent on debt payments or filed for bankruptcy.
All the information in your credit report is used to create a credit score, the most widely used being a FICO Score. Here’s what you ought to know about the factors that typically go into a FICO Score: payment history, amounts owed, length of credit history, new credit, and credit mix.
• Payment history: This is typically the most important factor in your credit score because a lender wants to know if a potential customer has paid past debts on time. Tip: Pay your bills on time, and if you miss a payment or are late for whatever reason get current as quickly as possible.
• Amounts owed: Owing money is not a bad thing, but maxing out 10 credit cards might be. Your credit score takes into account total available credit and what percentage of that total is being used. Tip: Keep low balances on credit cards, and remember closing unused cards may lower your credit score because that lowers your total available credit.
• Length of credit history: Your FICO Score takes into account the age of your oldest credit account and newest account and the overall average age of all your accounts. Generally, a longer credit history increases your credit score. Tip: Be smart about opening new credit accounts (Do you really want another department store charge card just so they’ll give you 5% off those $100 shoes?). Also, think twice about closing old unused accounts since that will lower the average length of your credit history.
• New credit: Opening multiple credit accounts in a short time may be perceived as risky and may lower a person’s credit score. Tip: Avoid opening new accounts that you may not need.
• Credit mix: Although not a major factor, a FICO Score does consider the variety of credit a person uses, such as credit cards, auto loans, and mortgages. Tip: Having a credit card may help your FICO Score — but only if you manage your debt responsibly and make payments on time. Don’t add accounts just to try to raise your credit score.
For a more detailed look at FICO Scores, check out this guide from myFico.
A good way to start managing your credit more closely is to request a copy of your credit report from any or all of the three credit reporting companies. You are entitled to one free copy per year of your credit report from each credit service. To order your free copy, go to AnnualCreditReport.com.
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