In my opinion, credit scores are one of the most obscure and methodical concepts to a client. I’ve actually had clients tell me something they swore would help their credit, when in fact it was the complete opposite. One of the many examples I have is when I had a client tell me that he never fully paid off his credit cards because paying interest helped him get a better credit score. I’m going to explain to you what determines your credit score, the best way to get and keep a high score, and some common myths about your FICO score.
First lets go over what determines your credit score. There are 5 main factors. Coming in at 35% of your overall credit score is your payment history. Being late on any bills, or even worse having them go into collections, is the easiest way to drop your credit score. The good thing is that if you’ve always been on time and for some reason you forget to pay bills one month, it won’t impact you too much in the long run. Initially yes, it’ll drop it a bit, but after a while it just fades away and your FICO regains its strength. The second largest factor at 30% is the amounts you owe. If you have 5, 10 or even more credit cards and they’re all maxed out, it shows you’re a high credit risk b/ you cant seemingly pay your bills off. Length of your credit history comes in at 15%. Ideally 7 years or more is what is considered a long credit history. Finally at 10% each is New Credit requests and type of credit mix in use. New credit is in reference to how often you run your credit – be it for a cell phone, car loan or any other type of credit. If you’re consistently running your credit, its probably doing you some harm. Type of credit mix in use basically comes to what type of accounts you have open. The ideal situation is some mystery mix of a home loan, car loan and 2 to 3 credit cards. That doesn’t mean you should go get a car loan when it doesn’t make sense financially. Remember, it’s only a small factor, and so long as you have some credit in use you’ll be just fine.
When it comes to getting and keeping a high FICO score, there are a few guidelines you should follow. First and foremost, is to make absolutely sure that you pay all your bills on time. As a reminder, I set an alarm on my phone, which is synced to my email. Every first of the month, my phone and outlook both remind me that it’s time to pay all my bills. Secondly, is the length of your credit, ideally you want 7 or more years of credit history. Finally, you want at least two but no more than four credit cards with high limits. Other than these three things, the best way to get a high score is to avoid any court judgments, past due bills, and collections.
In regards to keeping your high credit score, note that credit cards usually become people’s biggest downfall. Yes, you DO want high limits on your credit cards, but that doesn’t mean that you’re supposed to max them out. The fact that lenders trust you with a high credit limit, is actually a good thing. The key is to never have more than 25-30% on one credit card. For example, if you have three $10,000 limit credit cards, you don’t want to have 1 card with $9000 on it, and the other two with nothing. Technically, you don’t want $9000 of credit card debt at all, but if this is your scenario, it’s better to have $3000 spread out on each of the three credit cards. This makes it seem like you know how to handle your debt more efficiently.
Now lets debunk some of the myths we all commonly hear. First, having to pay interest because you did not pay off your credit card in full, will ABSOLUTELY NOT help your credit score. Again, it is the debt to credit limit ratio, that will be taken into consideration. Second, that Best Buy payment plan that you’ve never been late on will help your credit score. This is completely FALSE, the only payment plans that will ever show up on your credit as mentioned above are structured payments, such as a house or car, and revolving payments, such as credit cards which we already discussed. Other things that will not show on your credit report unless they send you to collections are your cell phone bills, electric bills, and even those store credit cards without a Visa, MasterCard, Discover, or American Express logo on it. Remember, without any of those logos, those credit cards, do absolutely nothing to help your credit. Number three, if you don’t use a credit card that you’ve had for years on end, you should close the account. Again, this is FALSE. Remember, long credit history is good. You especially don’t want to close this unused credit card if it has a high limit. In fact, you should probably use it once every few months on something very minor, such as socks… just to make sure they don’t close it due to inactivity.
Remember, your FICO score is your reputation to the financial world, guard it with your life. Just because you have a lower credit score doesn’t necessarily mean you won’t ever be able to get a loan for anything, but having a better credit score, will almost guarantee that the same loan will be easier to finance, and will be much much cheaper, saving you thousands to tens of thousands of dollars every year… Now that’s good to know 🙂