Your Credit Score is critical when applying for loans and can also affect other financial components of your life including several types of insurance. Understanding and optimizing your credit is important to receiving the best terms on loans such as mortgages and better rates for life & auto insurance. There are 3 major credit bureaus: Equifax, Trans Union & Experian. All three have their own data bases of your credit history and all three have separate algorithms for calculating your credit score. They also have different credit scores for different industries, for example your score for an auto loan or student loan may be different than for a mortgage or insurance company. Between the three companies there are 49 separate credit scoring models.
Only credit accounts such as credit cards, auto loans, student loans, mortgages etc. are included in your credit score. Utilities, cable bills, telephones, rent, and medical bills are not included in your credit score unless they go unpaid and the company files a collection account or judgement against you which then become significantly negative to your score.
Your credit score is comprised of 5 primary components:
Payment History – 35%
Amounts Owed – 30%
Length of Credit History – 15%
Credit Mix – 10%
New Credit / Age of Accounts – 10%
The largest factor in your credit score is your payment history. Making the minimum payment on time is FAR more important than making the entire payment late. Payments are deemed late by the credit bureaus when they are reported paid a full 30 days after the due date. You could conceivably make your payments after the 2-week grace period and before the 30-day late date and although pay a late fee, still be recorded as paid on time with the credit bureaus. This is an extremely costly way of handling debt so don’t do it if possible. Set up auto pay and organize yourself too make sure all payments are made on time. Don’t ignore an account charge you disagree with. Dispute it and get it resolved. In the long run, it’s usually not worth being stubborn and not paying as you might win the battle and lose the war when your credit score drops 100 points for non-payment.
The amounts owed is the second largest component of your score. For the most part, this relates to credit cards and lines of credit. The bureaus determine how much you owe relative to what your overall credit limit is to determine your “usage”. The higher your usage percent of your line, the lower your credit score. Therefore, you might want to think twice about closing unused cards if you carry balances on other cards as your usage percentage will increase. This creates a concern because closing unused cards is advisable from a credit protection / identity theft standpoint so be mindful of how you handle this decision. The ideal situation is to pay down balances as aggressively as possible. As a mortgage professional I often marvel about people who maintain credit balances while at the same time have large savings balances. It makes no sense from a financial standpoint to earn 1% on your savings while paying north of 13% on credit cards, effectively losing 12% on the amount you owe and at the same time negatively affecting your credit score with a higher usage.
Length of Credit History. For the most part the last 24 months weighs very heavily on your current score and older items, even foreclosures and bankruptcy filing will have a negligible effect as they age over 24 months.
Article by: Don Rizzo, President
Voted as Top 1% Loan Officer by United Wholesale Mortgage