Have you ever wondered what a credit score is and how it works? Somewhere out there in the cyber world is a three-digit number (ranging from 300 to 850) that provides a snapshot of your “credit worthiness”. Your credit score is a component in helping to determine if you qualify for a loan. Of course, the higher the number, the better! WOW, how do they know and what makes it high or low? They know because your bank and creditors report your payments to the credit bureaus monthly. The number depends on you!
Here are the main factors that make up your score.
Length of Credit
looks at how long your accounts have been opened. Any loans or credit cards you already have will help build your credit history. The longer you have had a credit card or loan the better the history. If you have multiple credit cards and decide to close some of them out, keep the older cards as they show a longer credit history.
There is a “mix of credit” that lenders look at. This includes both revolving credit lines (credit cards, home equity or personal lines of credit) and installment loans (auto loans, etc.).
is the percentage of available credit that has been borrowed. Say you have a credit card with a $1,000 maximum credit limit and you have borrowed only $300 against that limit, that’s good. However, if you have maxed out the card at $1,000, that hurts your credit. You should never borrow more than about 30 to 35% of your credit limit. Anything above these percentages works against your score.
is the largest portion of your credit score (about 35%). In other words, making on-time payments each month can improve your credit score more than any other factor. It is doubly important to consistently pay your auto loan or other installment loan on time as the installment loans take precedence over revolving credit. By paying on time, you will establish the dependable track record that lenders look for. As your score increases, you’ll be more likely to qualify for better interest rates on not only auto loans but mortgages and personal loans as well.
Before you sign on the dotted line, make sure that the terms of your loan are ones you can live with over the life of the loan, the amount, due date, etc. Consider setting up automatic payments out of your checking account or set payment reminders so you don’t forget to send your payments on time. These steps will help you stay on track and keep your credit score on an upward climb.
If you have enough money that you never need to borrow any money, that’s great! BUT if you are like most of the people in this world, you need a good, healthy credit score.
“A good financial plan is a road map that shows us exactly how the choices we make today will affect our future.” – Alexa Von Tobel