February 1, 2019
Establishing and maintaining a credit score is difficult. Not only is arguably the most vital piece of information left out of the welcome packet received from your credit supplier, but opening a credit card in the wake of other debt can be stressful. Understanding the most significant contributing factors to your score can not only reduce your borrowing cost, but also give you piece of mind knowing that you have a plan.
Outlined below are some of the ways in which your score is determined and the weight (or effect on your credit score) it has.
~35% Payment History: Paying on time has its perks, failure to do so can have serious consequences on the score you’ve been trying to build. Even just one missed payment can wreak havoc on it, make sure you set up alerts or reminders in your phone to remind yourself when payment is due.
~30% Credit Card Usage: the percentage of your total credit limit that you have spent and yet to repay. This signals to lenders the level of self-control that the borrower possesses. Try to keep this below 6% of your total limit to maximize its potential lift to your score.
~15% Length of Credit History: The amount of time that you have had open credit account. This is why it is important to start early in your career if you feel comfortable with opening an account. The longer that ratings agencies can see consistent payments on your account the more trustworthy you become.
~10% Hard Inquiries on Credit: When your credit score is checked for a large purchase or when you open a new line of credit.
~10% Credit Mix: According to FICO, historical data indicates that borrowers that possess a good mix of revolving credit and installment loans (think car or house) generally represent less risk for lenders.
You also may have heard about a new “Ultra FICO” score. It is a test program that is being tested by Experian (one of the major credit reporting agencies) to help those with little or bad-fair credit under the current model. It’s rolling out beginning in 2019 and factors in consumer savings, checking, and money market accounts. Those with a “moderate amount” of savings (defined as $400 or more) could increase their score to the next rating, possibly lowering their borrowing rate or qualifying them for better credit cards. It is definitely something to consider if you are close to a higher rating level, have $400 or more in your savings account and have not had a negative balance recently in your accounts.
All things considered, credit card companies are taking a risk every time that they lend money to someone who opens an account. Credit lending has an unfortunately inherent Akerlof’s lemons dilemma (think sleazy used car salesman who knows the car he’s trying to sell you was just totaled or in this case someone who wants to run up their credit charges only to declare bankruptcy), the more information, diversity, and payment history that you can show on your past record helps creditors mitigate some of this risk.
Remember credit cards aren’t inherently bad or as Bobby Boucher’s mother (from Waterboy) would say “The Devil”, if they can be used responsibly they can significantly reduce your borrowing rates for the large purchases you will have in life. Just make sure to keep in mind the factors mentioned previously and have a plan for your spending habits.