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The 5 Components of a Good Credit Score

We are bombarded constantly about how important our credit score is. What do we actually need to know? We asked our ‘resident expert’, Dean Hartman, to shed some light on the matter. – The KCM Crew

Everyone knows that you need a good credit score to get a mortgage.  Most even know that your score will affect the rate and fees you pay for your loan; but few are aware that your credit score also is a determinant of your homeowners’ and auto insurance rates and a myriad of other things.

Simply put, your FICO Score has a huge impact on your financial life.  So, how can we get the best possible score?

There are five components to your score:

1. Your Credit History makes up 35% of your score.

This is obvious.  How you have paid your responsibilities before is a good predictor of how you will pay them in the future.  While your credit profile will look back seven  years, the most weight is given to your activity and performance over the last 24 months.  Here’s a little known tip about your credit.  Let’s say, you have a “charge off” for a cell phone bill you didn’t pay 5 years ago.  Today, that “charge off” has little impact on your score.  Many people, as they prepare to buy a home, will just pay the “charge off” to clean up their credit report.  Makes sense, doesn’t it?  However, by doing this, you will move the activity on the “charge off” to now (which is in the two year window), actually lowering your score.  Before you do anything like this, talk to your mortgage professional!

2. Your Amount of Credit makes up 30% of your score.

Now, this is not your total amount of outstanding debt (as you might assume), it is the amount of debt you have divided by the amount of debt you have available to you.  As an example, a client who owes $5000 on their one credit card that has a $5000 limit will have a lower score, than a client who owes $100,000 in credit card debt, but has $250,000 in available credit lines because their percentage of usage is lower.   Optimally, you want to target 30% or less usage of your available credit.   Many people cancel some of their credit cards before applying for a mortgage because they think it will help their application, since (logically) they think less credit availability means they are less likely to “get in trouble” and that’s a good thing.  They are WRONG.  Canceling those cards lowers the amount of available credit, driving their percentage of usage higher, lowering their score.

3. Your Length of Credit History makes up 15% of your score.

This makes sense too.  A consumer who has paid all their bills for 20 years deserves a better score than someone who has paid their bills on time for 20 months.  This is another instance where some people cancel credit cards and it hurts them because the cards they cancel reflect a longer payment history.  Be careful to consider this factor before deleting any account from your credit history.

4. The Types of Credit You Use names up 10% of your score.

Mortgage payments, auto and student loans (really installment debt of any kind) are weighted most.  The payment is typically fixed in amount and due date; therefore, “missing a payment” on one of these accounts usually indicates a problem more than carelessness.  Your major credit cards (like Visa and MasterCard) have variable payments and due dates.  Additionally, there are times when you buy something and return it, but during the time in between a bill was issued.  You get the bill.  You know the item was returned.  So, you don’t make a payment.  The credit card company can still report you for missing a payment (damaging your score).  This is why store-issued credit cards carry even less importance.  They love reporting you late to make it harder for you to get a credit card at a competing store.

5. Your Credit Inquiries make up 10% of your score.

The scoring models now cluster your inquiries.  What that means is that if multiple people within an industry run your credit within a 45 day time period (you’re shopping for a car or mortgage, for example), all those inquiries are treated as one.  But, if you shop for a mortgage and a car at the same time you are trying to increase your credit card limits and get life insurance, your score can be lowered by as many as 55 points.

You need to be aware of what your actions can do to your score.  You need a consultation with a professional.

Next week, I will tackle the more frequently asked questions that we get from people about their credit scores.

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