Understanding the five fundamental factors of a credit report is a must when learning about credit. These five factors are equally applicable no matter where someone is in their credit journey, so it’s important to remember them.
Payment history constitutes 35% of his overall credit score. Banks want to see that customers make timely and consistent payments.
A missed payment on his credit report is a huge red flag. For banks, this means they risk not getting back the money they lend to their customers. Even one late payment can drop your credit score by at least 50.
A good way to keep track of your payment history is to enable autopay on all credit cards held to ensure a payment isn’t missed. Another way is to use a credit card as if it were a debit card. People should never be charged more than what is in their bank account.
The “amounts owing” category represents 30% of a credit score. It shows how much money they have outstanding relative to their credit limits. Banks don’t want customers to use the full line of credit they give them, but rather they want it under a special, magical percentage, which is also 30%.
This means that for a $1,000 line of credit, use $300 or less for a good rating in this category. Having 10%, or in this case $100, is ideal.
A higher credit limit gives people more leeway. This is one reason why older people have higher credit scores. They have a longer credit age with higher limits, resulting in lower credit utilization.
It should be noted that the 30% and under rule must be followed for individual lines of credit and not for the total credit limit, so do not max credit cards.
The length of credit history counts for 15% of a credit score.
The easiest way to think about credit history is to make an analogy: if someone were to have open-heart surgery, would they choose the doctor who has been practicing for 30 years or the one who has only been practicing for one year? They would choose someone with more experience.
Would a bank rather lend to an experienced 40-something with a salary of $150,000 or to a student who does not have a stable job? Banks use the same logic when it comes to issuing loans.
Thus, it is advisable to open a secured credit card once someone reaches the age of 18. By doing so, one would have a decade of credit history before turning 30.
The distribution of credits counts for 10% of the score. Banks find it more attractive when customers have a good mix of credit products.
There are two main types: revolving loans, which include credit cards, and installment payments, which include student loans, mortgages, and car loans. This signals to banks that customers have experience handling different types of credit products.
Since the credit mix is only a small percentage of the overall credit report, people should not take out a loan just to improve their credit rating.
The new credit represents 10% of the score. Banks don’t necessarily see opening 10 credit cards in two months as a good sign. The bank would rather wonder why this person needs all this new debt.
Each time a person applies for new credit, a thorough investigation is done on their account, i.e. whether they have been approved for the specific product. Serious inquiries stay on a credit report for two years, but stop impacting a credit score within a few months. People should be reasonable and space out their credit card requests.
When you buy a car from a dealership, come with ready financing, whether it’s an auto loan pre-approval from a bank or credit union. If not, the dealership will offer a better rate and give customers a bunch of difficult inquiries about their account. This should be avoided to take care of a credit score.
Next week’s column will focus on credit products and their different features. Until then, take care of that credit rating.