Maybe you’re just getting started in the world of credit card miles and points, or maybe you’re a veteran in these parts. Either way, one thing that is crucial to success when it comes to pursuing points is a good credit score. In this post we’re going to talk about what exactly is a credit score, and then we’re going to go over all of the factors that go into determining your score. In future posts we will talk about where you can go to check your scores free of charge.
What is a Credit Score?
Your credit score is a 3 digit number that is determined by taking into account a number of factors (which we’ll talk about shortly). It is used by companies to assess the risk associated with giving you access to credit. Scores can range from 300 to 850 and at last count more than 90% of all financial institutions used credit scores as part of their decision making process. Generally speaking, a bad score will hurt you more than a good score will help you so its important to always be working towards your best score possible. When it comes to taking advantage of credit cards and their associated benefits most of the top tier cards are going to want you to have a score of around 700 or higher. Now, there are a lot of factors at play when companies decide whether or not to offer you a credit card so if you’re below 700 you’re not automatically disqualified by any means. As a consumer you’ve got 3 different FICO (Fair Issac Corporation) scores; Transunion, Equifax, and Experian. Each provider calculates your score slightly differently and depending on the use case a creditor may use just 1 or in some cases all 3 when determining your credit worthiness.
How Credit Scores are Calculated?
- 30% Payment History – In simple terms this is a measure of how often you’ve paid your bills on time for the length of your report. Companies want to know whether or not you’re going to pay them for money lent when the time comes. So long as you’re making your payments on or before their associated due dates you’re all good here.
- 30% Amounts Owed – This is a measure of how much money you owe in total and typically it is a factor of how much credit has been made available to you. For example, if you owe $1,000 and have $10,000 in available credit (the summation of all of your credit card limits) then your revolving credit utilization is 10%. Similarly if you owe $1,000 but you’ve got $100,000 in available credit then your utilization is only going to be 1%. My personal goal is to always have a credit utilization percentage of no more than 5% and typically I like to stay between 1 and 3%. The simplest course of action here is to make sure that you’re not spending money that you do not have which will allow you to pay your bills in full rather than making minimum payments and having these number climb higher than it should.
- 15% Length of Credit History – This factor is the average of the ages of all of your open credit accounts. For example, lets say your oldest line of credit is 5 years / 60 months, but you just recently signed up for a new card. When you sign up for that new card your average age becomes something like 61 / 2 which is ~30 months and it effectively cuts your length of credit history in half. This is one of the reasons that signing up for new cards can cause a momentary ding on your credit score. This factor is one of the reasons why you should never cancel your oldest line of credit because it essentially becomes the anchor point for this average. Generally speaking 9+ years is considered “excellent” while 7-8 is “good”, 5-6 is “fair” and 2-4 is considered “poor”. My current length of history is somewhere around 3 years given the fact that my oldest card is 7+ years and my newest is around 5 months. Even with that “poor” rating however, I am still able to maintain a score of 750+. Bottom line here is that this is something you should be aware of, but it shouldn’t necessarily scare you if your age is not 9+ especially if you’re young.
- 10% New Credit – When you go to sign up for a new line of credit the creditor is going to pull your credit report from 1 of the major bureaus, or in some cases all 3 if say you’re buying a home. When this happens it is known as a “hard inquiry”. A hard inquiry is specifically one in which a potential lender is reviewing your credit because you’ve decided to seek out credit from them. These types of inquires will cause another momentary ding on your credit score. After 24 months these types of inquires will “fall off” of your credit report. A soft inquiry on the other hand is one in which a company is pulling your credit score as if it were a background check. Soft inquires do not ding your score as they’re not made in a request for additional lines of credit. Generally speaking you want to keep this number low as companies may look at repeated inquires with suspicion. If you’re looking to buy a house within the next 2 years most people will tell you to get this number to 0 so that you’re in the best position possible to command the lowest rates. I personally have 5 inquires sitting on my report right now, but again I am currently at 750+ because this line item tends to have a lesser impact than the ones we’ve discussed previously.
- 10% Types of Credit Used – This is simply a measure of the types of credit that you’ve got on your report. Different types of credit would include things like; credit cards, mortgages, car loans, student loans, etc. Generally speaking it pays to be diversified and lenders may look more favorably upon people with a variety of credit types. That being said, you should not buy a house for the sole purpose of improving your score. I tend not to pay this factor much attention as I find it becomes balanced out over time so long as you’re making sound crediting decisions.
So there you have it, a brief overview of all the things that go into determining your credit score. If your score is not as high as you’d like fear not, in coming posts we will discuss how best to improve it. Bear in mind however that it does not have to be overly complicated. So long as you’re acting responsibly with your credit and paying your bills on time you should have no trouble earning and maintaining a positive score.
Have questions? Please reach out! I am happy to go over credit scores, their meaning, and how they can be improved any time! Feel free to leave a comment, contact us, or reach out on Twitter.