Breaking Down Your Credit Score
As lenders consider your application for a mortgage, credit card, student loan, or the like, your credit score is one of the key components in the decision to lend, and at what interest rate. Many employers are also reviewing your credit before finalizing an offer and landlords may check your score before renting to you. Understanding the components of the credit score calculation will allow you to improve your score and potentially give you access to more competitive interest rates.
The FICO calculation
FICO scores are the most common types of credit scores. Your FICO score is a number between 300 and 850. According to The Wall Street Journal, a score of 720 or higher will grant most borrowers access to low rates, although not the best available. Calculations are based on five factors:
The largest two components, which together comprise 65% of your total score, are your track record of paying on time and how much debt you have outstanding.
Ways to improve your score
Pay on time
Making the monthly payments on your credit cards and loans on time is the most effective long-term strategy for maintaining a good credit score. A late or missing payment can do serious damage to your score. Just one delinquency can lower your score by over 100 points.
Monitor your credit utilization
The FICO score is not just looking at your total debt, but also how much of your available credit you’re using each month relative to your limit. For example, if your credit limit is $10,000 and you have $1,000 in charges, your utilization rate is 10%. Low utilization rates are typically under 25%. You can lower your utilization by paying down your balance more than once a month.
Report errors on your credit report
Credit problems aren’t always your fault, but it is important to access your credit report to validate its accuracy and ensure you haven’t been the victim of identity theft. Federal Law allows consumers to get their credit report free every 12 months at AnnualCreditReport.com. Occasionally a report will contain errors – such as a missed payment. Credit reporting firms now allow disputes to be submitted online.
Weigh the pros and cons of closing unused credit cards
There can be benefits to keeping a credit card open, even if you don’t really need it. An old account will not only increase the length of your credit history, but also keep your credit utilization lower, as you have more available credit. Consider keeping a small recurring charge on an old card to keep it active.
There are certain situations where it may be advisable to close the account. Cards with annual fees, unfavorable terms, or a low credit limit might be worth a second look, especially if you are considering closing multiple accounts.
Some of these tips can begin to positively impact your score the following month. Others, like length of credit history and diversity of debt, of course will take longer. With some proactive monitoring and management, you should be well-equipped to take control of your credit.
Learn more about planning your financial future – contact a Darrow advisor today.
Kristin McFarland is an investment adviser representative of The Darrow Company, Inc., an SEC registered investment adviser located in Massachusetts. The material contained in this article is for general information only and should not be construed as the rendering of personalized investment, legal, accounting, or tax advice.