Who would have thought a mathematical formula could have such a direct impact on your life? An individual’s credit score is a significant factor which affects many areas of adult life. This can be a source of stress and obsession for many people: good credit will save you money, whereas poor credit will make your life immeasurably more difficult. With that being said, it’s important to know what a credit score consists of, what elements impact your score and what you can do to improve your chances at having and keeping good credit.
Since the inception of credit scores approximately 32 years ago, society’s economic infrastructure has relied heavily on this numerical calculation to determine the worthiness of individuals for renting a living space. Prior to credit scores, character-based lending was popular among lenders. Undoubtedly, this led to discriminatory lending practices, paving the way for the method we use today.
There are many types of credit scores, however the most widely used by lenders is called FICO. According to FICO, Credit scores consist of five factors: Payment History (35%), Credit Utilization (30%), Length of Credit History (15%), Inquiries and New Credit (10%) and Diversification of Credit (10%).
Payment history is a major factor, which is why it is important to pay your bills on time, every month if you would like to maintain good credit. If you are unable to make these payments on time, inform your lending company and request an extension so as to not negatively impact your payment history.
Credit utilization is the second most important factor in achieving good credit. It is recommended to keep your credit utilization rate under 30%, so if your credit card limit is $1000, you must never have more than a $300 balance if you want to appear to have a low credit utilization rate. Once you have a proven history of making payments to your credit card company, you can request a credit line increase, which if approved will automatically lower your credit utilization rate thus improving your overall score.
Thirdly, length of credit history. Many lenders have leniency when considering this factor, as this puts young consumers at a disadvantage due to their age. To combat a short credit history, apply for your first credit card early, and do not close this account! It is better to freeze your card as closing your credit card is guaranteed to negatively impact your score.
Inquiries and New Credit and Diversification of Credit play an equally important role in your credit score. Hard inquiries, such as when you apply for a new line of credit through a credit card company or buy a new vehicle will impact your credit score. This plays a minimal role in your credit, and these inquiries will be removed from your credit report after some time.
Diversification of credit is important because it demonstrates to lenders you are able to handle making payments across all forms of credit. Having a mix of secured and unsecured credit cards, as well as paying off your phone and utilities bill in full each month will satisfy this requirement.