What is my credit score and why does it matter?
It is embarrassing to admit, but when I graduated from college and started my career in finance, I had no idea what my credit score was, why it was important, or how to build and manage it over time.
Luckily for me, my girlfriend at the time, now my better half, grew up in a home where the basics of personal finance were discussed. With her advice and a little education from her father, it wasn’t long before I was building my credit.
Once I was aware of the impact that a credit score can have on your life, I started to take it seriously.
Your credit score, or FICO score, is a number that ranges from 300-850. Virtually all lenders use your credit score as a factor when you apply for credit. Whether you are applying for a credit card, a mortgage, a car loan, or refinancing your student loans, your FICO score will more than likely come into account. And typically the higher your score, the better the terms and rates you will be offered by the lender.
I know I know, this is sooooo boring. But IT REALLY MATTERS. Read on if you want to understand the basics of what goes into your FICO score.
What counts towards my FICO score?
Your credit score is essentially a report card of your credit history. The higher your score the better. Your score takes into account your payment history, the amount of debt owed, length of credit, types of credit in use, and new credit. These categories account for various weights of your score and the weights will vary depending on your credit history. Here is how the score breaks down for most people.
Have you behaved?
The biggest part of your credit score, 35%, is your payment history. Have you made your payments on time? Think about it. If you were going to lend money to your cousin and you knew he borrowed from your aunt in the past, wouldn’t you want know if he made good on his debt? Of course you would and it is no different here. Lenders want to know if they can trust you so they look to your past behavior.
Are you responsible today?
The second largest part of your score, 30%, looks at the amount of debt you owe today. This is a debt utilization ratio. Simply put, if you have one credit card with $3,000 available and owe $1,500 your debt utilization ratio is 50% ($1,500/$3,000). The higher the ratio, the riskier you will be viewed. Lenders want to know how responsible you are with your credit. It sounds weird but the higher your credit utilization, the less the lenders like you.
How long have others trusted you?
The length of your credit history makes up about 15% of your score. Lenders will take a look at the age of your oldest account, youngest account, and average account. Generally, the older your credit accounts, the better your score.
What kind of credit do you use?
10% of your score will factor in the types of credit that you use. Credit cards, installment loans (car loans), mortgage accounts, etc. Lenders want to know what types of credit you have used responsibly in the past as well as what types of credit you have outstanding today.
Who are you asking to borrow from?
10% of your score looks at new credit. Are you applying for a credit card and you just got a new card last week? Are you shopping around for rates on your new car loan? These are all factors that fall here.
Do you know your score?
If you want to know your score, you can find out for free at Credit Karma . You can also receive a free copy of your credit report from Experian, Equifax, and TransUnion at annualcreditreort.com Once you know your score and have your credit reports in hand, we can discuss how to improve and manage your credit score over time. And that is exactly what we will do in our post next week.