Understanding how credit scores are generated is the key to knowing how to improve and raise your credit scores.
Let’s start from the beginning as to what credit scores are. Credit scores range from 300 to 850. A credit score is considered good above 669. Scores are a prediction on how likely you are to repay debts. Think of scores as your trustworthiness new lenders have towards you based on how you have treated other lenders.
There are 5 categories of your credit file that together, generate a credit score. The categories are:
- Payment history
- Amounts owed
- Length of credit
- Mix of credit
- New credit
If you have low credit scores, you are probably not doing well in at least one, if not several, of these categories. It’s going to take time and effort to build your trustworthiness with lenders, but it can be done. Have your credit report handy as we review the categories in depth. You will see what you need to work on in order to improve and raise your credit scores.
1. Payment history is 35% of your score.
This includes when you have paid on time and paid late. If you have any late payments within the last 2 years, your scores are going to be lower because of this. Late payments stay on your credit report for 7 years. You must pay all your accounts on time every month to improve this category to help raise your scores.
2. Amounts owed is 30% of your score.
This includes the amount of debt you owe in total on all your accounts. Do not be tempted to pay off installment accounts early thinking you will get score increases. Revolving accounts are weighted far more heavily than installment accounts.
Look over your credit card balances compared to the limits. If they are above 30% utilization this is lowering your credit score. Stop using the cards and work on paying the accounts down. Paying your credit cards off each month to reflect 0% utilization is the ultimate goal, but a 30% utilization is a great goal to work towards.
Start off by paying down your credit cards with the highest utilizations first. Paying the minimum payment may be all you can afford at this time and that’s fine, but paying more than the minimum payment will reduce your utilization faster causing your credit scores to rise faster.
3. Length of credit is 15% of your score.
This is when your oldest account was opened compared to when your newest account was opened and then averaged together. Your trustworthiness is built upon long term consistency of properly managing your credit. Lenders want to see longevity. Unfortunately, length of credit is based on real time. Each month that passes, it only adds one month more to the length. Opening, closing, and refinancing accounts will reset your average age.
One way you can increase your length of credit is to be added as an authorized user to a credit card. This should be a person you know that has a credit card that was opened at least 3 years before your oldest account was opened, no late payment within the last 2 years, at most 1 late payment within the last 7 years, and has a utilization below 30%. This account will show up on your credit report and will help extend your length of credit. It also will help with your payment history, amounts owed, and credit mix. If you have no one that has a credit card in standings such as this, you will have to allow your accounts to age naturally and your score will gradually increase over time.
4. Mix of credit is 10% of your score.
This is the amount and types of accounts you have experience with. Lenders and creditors want to see your ability to manage multiple accounts. You need both revolving and installment accounts.
Revolving accounts are bank credit cards, retail store credit cards, gas station credit cards, personal lines of credit, and HELOC (Home equity line of credit).
Installment accounts are auto loans, mortgages, personal loans, and student loans.
When you look over your credit file, you will need to look at the type of accounts you have open. A good mix will have at least 5 accounts open with either a 1:4 ratio or 2:3 ratio. This means 1 installment with 4 revolving or 2 installments with 3 revolving. You want to have more revolving accounts than installment accounts. You will achieve higher credit scores over time with the proper mix of credit.
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5. New credit is 10% of your score.
It is affected by the amount of inquiries you have and how long it’s been since you opened your most recent account. Every time you apply for credit you are most likely going to get an inquiry added to your credit file. Inquiries stay in your file for 2 years but only impact your score for the first 12 months after the date of inquiry.
If you have applied for credit too many times, lenders will see that as a sign that you may be financially distressed and in need of credit compared to simply wanting credit. Stop applying for unnecessary credit when trying to raise your credit scores. When you do open a new account it can be good and bad for your credit. New accounts negatively impact your credit score because an inquiry is added to your file, your average length of history is lowered, and your amounts owed increases. New accounts positively impact your credit score because it helps your credit mix, your amounts owed decreases over time, and you have an account reporting on time payments. Short term, yes, you will lose some credit score points for opening an account, but in the long run it’s going to raise your credit score higher than what you could have achieved before opening the account.
If you have negative/derogatory items on your credit such as collections, charge-offs, bankruptcies, late payments, and many inquiries, they are lowering your credit scores. Over time, these items will not impact your credit scores as much and will eventually fall off your credit report like they never existed.
This is when a credit repair company may be of assistance to you. They help you manage your credit by guiding you to build a solid credit file while also challenging/disputing the accuracy and completeness of accounts in order to get the accounts removed before they naturally fall off your credit file. Raising your credit scores is not a fast or easy process depending on where you are starting and how much effort you are able to put into it, but with persistence and patience, you can do it!
Author:
Shannon McKee
EPL Credit Refinement
www.eplcredit.com
Sources used for this article: www.myfico.com, www.experian.com, www.equifax.com
Disclosure: CreditCardGuru.com is a credit education and and online credit resource. At times, other credit experts will also provide informational content on our website. This information is not financial advice and is for informational purposes only. CreditCardGuru.com shall not be held responsible for any inaccuracies in the this article. This specific blog has been provided by the credit expert listed above and we thank them for their contribution.