What is a Credit Score?
Many of you might be wondering how you can acquire expensive items like luxurious houses, shiny jewelry, and fast cars. The short and simple answer is: maintain a good credit score. According to Investopedia, a credit score can be described as a number between 300-850 that depicts a lender’s risk of lending you money; this number is given to you as you use credit cards, pay bills, and/or reduce your debt. Meaning that the higher the score, the more money you are likely to receive from a lender.
Still, confused? Let me break it down for you. A credit score is calculated by your Fair Isaac Corporation (FICO) score; your FICO score is unique to you and is calculated six months after your first line of credit is opened. Everyone’s FICO score is calculated differently, depending on the user, but here’s the general gist of it.
Your credit score is subjected to five distinct categories:
Payment History (35%)
This category speaks for itself. The biggest component of your credit score relies on whether you have paid past credit accounts on time. As a result, this helps give the lenders an estimate of how much they risk when expanding your credit. Always make sure to pay your bills on time in order to grow your credit score! A good strategy is to set up automatic monthly payments so you never forget to pay it.
Amount Owed (30%)
When you use credit cards and owe money, it does not necessarily mean you are a high-risk borrower. Nonetheless, this percentage of your credit score relies on whether you utilize a large amount of your credit line. For example, if you get a credit card with a $2000 limit, and rack it up to $1800, you are utilizing a large amount of your credit limit. Overextending the amount you spend might be an indicator that you are high-risk, so always remember to pay back as much as you can before your payment due date. The best rule of thumb is to only spend what you can pay back in 30 days.
Length of Credit History (15%)
Having a longer credit history will generally increase your scores but there are other aspects taken into account, such as
- How long you have had credit accounts (average age of all accounts)
- How long it has been since you have used a specific account
Always remember to utilize your active accounts and do not wait too long to open a different one, as it will bring your average age down. It doesn’t do your credit history any good to open a credit card and close it a year later, then open another card and close that one let’s say 2 years later. It’s much better to open one credit card and keep it open.
Mix of Credit (10%)
It is not necessary to have a mix of all types of credit accounts: credit cards, retail accounts, loans, and more. However, FICO Scores do look at whether you have a variety of credit, simply to determine if you are reliable enough to take one in the future.
New Credit (10%)
Finally, this ten percent of your FICO Score is dependent on whether you have taken new lines of credit out in a short span of time. This is not recommended and shows high-risk, especially in a new account. Always try to avoid opening new accounts too rapidly.
Conclusively, maintaining a great credit score is difficult, but is crucial to providing opportunities that allow you to purchase and expand many aspects of your life. Remember those nice cars, huge houses, and expensive jewelry I mentioned earlier, those are just some of the pleasant items you will be able to acquire with good credit, in conjunction with other important financial aspects like debt to income ratio, income, and employment. (we’ll talk more about those aspects in the near future) On a smaller scale though, if you’re thinking about renting a place in the near future, landlords and management companies also look at your credit score, so it’s never too soon to start working on building your credit score.
So, always remember to be responsible in managing your lines of credit; you can do so by putting dates on calendars, setting times to pay all bills, and much more. Building and managing credit can be daunting, but it is an important skill to be learned. If this information was helpful, please check out the other articles I have published. My name is Bryant Marrero from the #AskBryant section and join me next time on “How Can I Build My Credit Score.”