When it comes to our credit score, we’ve heard of a couple things that we know affect our credit. We all know that we need to pay our bills on time or we will take a credit hit. That’s a no brainer. Most of us are probably aware that if we apply for credit to too many places in a short amount of time, that has a negative impact on our credit as well. Both of these are true, but there’s much more to our credit score than just these two items.
Our credit score is actually affected by five different elements. Here is a list of the items that affect our credit score and how much they weigh towards our score:
1. Payment History (35% of your score)
Yes, paying your bills on time is important. You don’t want to be late. You don’t want to default on any loans. You don’t want to be sent to the dreaded COLLECTIONS!!! This element of your credit carries the most weight so be sure to pay your bills on time.
2. Amount Owing (30% of your score)
This comes down to your Credit Utilization Ratio. This is percentage of your total available credit that is currently being utilized. For example, if you have $1,000 of credit available, it is better to only have $200 of that credit tied up than $900 of it tied up. $900 will give you a higher Credit Utilization Ratio and bring your credit score down. So if you have three credit cards with a $5,000 limit and have them all maxed out, you can be sure that this element of your credit is going to drastically bring down your score.
3. Credit History Length (15% of your score)
A small percentage of your credit score depends on the length of time you’ve have various credit accounts. For example, you will be hurting in this category if you open and close credits cards, every year, by transferring balances from one to the other. This shows a bunch of short term accounts and hurts your credit history. You’re better off to have one or two credit cards open for 20 years than 20 credit cards opened and closed in 2 years. Keep at least one credit card open so you have that history. You don’t have to keep a balance on it, though you may have to use it once in a while to keep it open.
4. New Credit (20% of your score)
Every time you apply for credit, a hard inquiry is performed, which temporarily brings down your score. If you go to four different places applying for a loan, you will get a hit on your credit. This is why you should avoid opening too many lines of credit before trying to finance something like a house or car. Your interest rate is impacted by your credit, so be sure to limit the hard inquiries against your credit.
5. Types of Credit (10% of your score)
This is the smallest contributor to your credit score. The more types of credit you have access to, the better you will score here. Three types of credit to be familiar with are: Credit Cards, Installment Credit, and Open Credit.
Credit Cards give you the flexibility of making purchases, transferring high balances, and the borrowing of cash.
Installment Credit is a loan of a fixed amount, fixed payments, and an established payment schedule.
Open Credit is known as a charge card. You have to fully repay these to avoid penalties, but there is no interest rate on these cards.
There are many elements that affect your credit score. It’s not just about paying your bills on time, though that is a pretty big part of it. Understand these five elements of credit if you want to drastically improve your credit score. A great credit score can save you thousands of dollars in interest and take the sting out of borrowing money for those big financing purchases. Remember that increasing your Financial IQ is the best way to be in control of your finances. Understanding these five elements is essential for increasing your Financial IQ.