What is the breakdown of a credit score?
Your credit score is a reflection of several factors of your financial life to date. There are five critical factors that impact your score, also called a FICO number, and each of them has a different percentage, or weight. Sometimes its hard to understand where it actually comes from, and it can be frustrating to understand rises or drops in your score.
What Actions or Activities Impact My Credit Score?
There are five different factors that impact your credit score. By changing just a few actions, you can actually change your score pretty easily, though it will take time.
The five credit score factors are:
- Paying bills by the due date: Most important factor, counts for 35% of your overall number
- Amount owed in relation to credit cap: counts for 30% of your score
- Length of account life, or length of time you’ve been paying on the debt: counts for 15% of your score
- New accounts: counts for 10% of your score
- Mix of credit (secured vs. unsecured debt): counts for 10% of your score
Carefully study the weights or percentages listed with each item above. If you’re able to pay your bills on time but just don’t get it done, you have your first task. The simplest way to address this is to set up automatic withdrawals, but not everyone is comfortable with this. If not, make an arrangement with a friend who has their financial stuff together and have a phone meeting on payday. Sit down at the computer or desk where you pay your bills and get it done each payday. Even if you can only pay the minimum, make the payment.
If you can’t pay the minimum, contact the owner of the debt. You may be able to get a forbearance or an extension. Once things get sent to collections, your credit score will take some hard hits, so do what you can to prevent this.
The amount owed refers to your credit utilization ratio. If you have a credit card with a $5,000 limit and you owe $4,500, it will have a negative impact on your score. If you can get that debt below $1,500, or 30% of the limit, it will have a positive impact.
The time you’ve been paying on a debt can actually be a big help to your credit score if you’re managing it well. Every payoff to a lender that reports to the three main credit rating agencies:
equals a good “ding” or hit on your credit report; late payments or non-payments equal bad dings. If you have a long history with at least one lender, maintain it carefully.
Applying for one new credit card is not going to be a big problem for your credit rating, but applying for several can lower your score. For example, if you raise your score and are able to pre-qualify for a mortgage but then open several accounts picking out new furniture for your new home, you may find that your score drops before you can close on the mortgage. Open new accounts with care.
Your credit mix refers to secured vs. unsecured debt. If you are making all your payments one time and getting your ratio down but your credit score isn’t going up, it could be because all your debt is unsecured, such as credit card debt. A loan with collateral, such as a car or another tangible item, could make a difference.
How Do I Raise My Credit Score?
Order a free copy of your credit report and review it carefully. No, this isn’t fun. It can actually be quite painful. However, once you have this data in front of you, you can look for errors.
Some of these can be simple to fix. For example, if your loan account was set up wrong, such as a transposition of your social security number, you may be able to get an old debt off your report. Once you’ve reviewed your report and cleaned up any errors, you can get to work on bringing your score up.
If you have a habit of being late, try to pay bills as soon as they come in. For those who don’t have the cash to cover debts until payday, consider a hard financial shutdown just for a month to build up the cash reserves to cover debts before payday.
Start with a free-kend: From Thursday evening to Monday evening, spend no money whatsoever. Stretch this into a 10 day no-spend, which will take a little planning, but will be completely worth it. Remember, you’re not completely shutting down your financial fun forever. It’s just a month to help you get ahead. Don’t starve, and don’t run out of gas. Other than that, don’t spend.
To review your utilization, open a spreadsheet and rank your debts by four columns:
- Total amount owed
- Interest you’re paying on the debt
- Total loan payment
- Total available credit
If you’re ready to start wiping out debt, the top three items are your number one concern. For those who need to rapidly raise their score, once the bills are getting paid on time, the fourth item in the list above is critical.
There are two pay-off processes you can use to wipe out debt. The first is the snowball. To use the snowball method, rank your debt from smallest to largest. Make the minimum on all payments but the smallest debt while piling everything you can spare on that top item. When you wipe out the littlest debt, roll the payment amount onto the next one. An avalanche is similar, but you rank the debt from highest interest rate to lowest and pay off in that order.
If you need to free up cash quickly, rank your total loan payment from largest to smallest. For example, if you’re planning a move or saving for a down payment, wiping out the big payments and freeing up cash for savings can change your financial picture.
Finally, track what’s owed against the total credit cap for each account. Getting your credit utilization in order really won’t make that much of a difference to your bill-paying process, but it will help your score almost as quickly as paying bills on time.
A Word on Consolidation Loans
A consolidation loan is a big patch for your sinking financial ship. However, it’s easy to get into a lot of trouble with a poorly managed consolidation loan. If you have multiple credit cards to pay off with your consolidation loan, retire the cards, or at least put them away so they’re hard to get to and a hassle to use.
Remember that consolidation loans report to credit bureaus just like credit cards and utilities do. If you’re not able to make these payments on time, you can actually do your credit more damage over time.
If you are fully able to make the payments, consider asking for help, such as a co-sign, from a friend or family member that has good credit. Do not do this if there’s a risk of default; you can destroy relationships this way and it’s just not worth the wreckage. Should you have someone in your life who will co-sign for you, get in the habit of paying the bill early and notifying them that you’re staying on top of it. Your debt will impact their ability to borrow, and if you default on the loan, you will hurt their credit too.
Improving your credit score will take months. Sign up for free monitoring so you get a notification of changes, especially payoffs, and check your score after the first of the month to note your progress. Once you know what factors to tackle, you can raise that number