The Importance of Credit
Good credit is necessary if you plan to use credit to make a major purchase, such as a car or a home. The importance of good credit extends beyond purchases, in that it may be used by potential employers and landlords as part of the selection process.
Your credit score is a three-digit number generated by a mathematical algorithm using information in your credit report. It's designed to predict risk, specifically, the likelihood that you will become seriously delinquent on your credit obligations in the 24 months after scoring.
What makes up my credit score?
35% Payment History
The first thing any lender wants to know is whether you've paid past credit accounts on time. This is one of the most important factors in a credit score.
30% Amounts Owed
Having credit accounts and owing money on them does not necessarily mean you are a high-risk borrower with a low FICO® Score. However, when a high percentage of a person's available credit is used, this can indicate that a person is overextended, and is more likely to make late or miss payments.
15% Length of Credit History
In general, a longer credit history will increase your FICO® Score. However, even people who haven't been using credit long may have a high FICO Score, depending on how the rest of the credit report looks.
Your FICO Score takes into account:
- How long your credit accounts have been established, including the age of your oldest account, the age of your newest account and an average age of all your accounts
- How long specific credit accounts have been established
- How long it has been since you used certain accounts
10% New Credit
Research shows that opening several credit accounts in a short period of time represents a greater risk - especially for people who don't have a long credit history.
10% Types of Credit Used
The score will consider your mix of credit cards, retail accounts, installment loans, finance company accounts and mortgage loans. It's not necessary to have one of each, and it's not a good idea to open credit accounts you don’t intend to use. Closing an account doesn’t make it go away. A closed account will still show up on your credit report, and it’s history will be considered by your FICO Score.
Your credit report acts as your financial reference when you apply for new credit. The only way to build a good credit history is to use credit wisely.
Following are 10 tried and true tips for building credit:
- Set a budget and live within it. Credit should not be used to live beyond your means.
- Provide complete, accurate and consistent identification on your credit applications. This information helps set up your credit history correctly from the beginning, ensures that your new accounts will be matched to the correct report and minimizes the chance that your credit file will be incomplete.
- Pay your bills on time. Late payments, called delinquencies, negatively affect your ability to get credit since they indicate a stronger likelihood that you will make late payments again or will be unable to pay your debts in the future.
- Have some credit, but not too much.Having no credit history is almost as bad as having a negative credit history, and you only need a few accounts reported to the credit reporting companies to demonstrate credit management.
- Have a mixture of credit types. It is good to have a history of repaying an installment loan, but a revolving account demonstrates more clearly that you can responsibly manage credit.
- Keep credit card balances low. Keeping your balances low compared with credit limits shows that you aren’t tempted to charge more than you can pay. By charging a small amount on at least one card and paying the balance on time, you will show that you can handle larger amounts of available credit.
- Use caution when closing accounts. Closing an account isn’t always a good thing. It can result in an increase to your balance-to-limit ratio, making you appear to be an increased credit risk.
- Be aware of your debt-to-income ratio. Mortgage lenders consider your monthly payments compared with your monthly income.
- Demonstrate stability. Some creditors consider your length of employment, length of residence, whether you own or rent and if you have any savings in making credit decisions. 10. Contact your lenders if you fall behind on your payments. Many lenders will work with you to set up a different payment schedule or interest rate.
If you have negative information on your credit report, such as late payments, a public record item (e.g., bankruptcy) or too many inquiries, you may want to pay your bills and wait. Time is your ally in improving your credit scores. There is no quick fix for bad credit scores. The length of time to rebuild your credit history after a negative change depends on the reasons behind the change. Most negative changes in credit scores are due to the addition of a negative element to your credit report, such as a delinquency or collection account. These new elements will continue to affect your credit scores until they reach a certain age. Delinquencies remain on your credit report for seven years. Most public record items remain on your credit report for seven years, although some bankruptcies may remain for 10 years and unpaid tax liens remain for 10 years. Inquiries remain on your report for two years.
If you want to see what is on your credit report, free of charge, check out www.annualcreditreport.com.