Credit scores can be a tricky business. For someone who is new to personal finance and financial responsibility, credit scores can seem a bit of a mystery. There are many facets to your credit score—several things impact your score and there are several ways to maintain a better rating. Of course, before worrying too much about what your actual score is you should try to carefully understand what a credit score does. Most lenders and banks use a FICO score to obtain a fast and objective measure of your credit risk. This FICO calculation gives lenders a snapshot idea of how reliable you are at paying back money and how responsible you are with money in general. For this reason, it’s important that you do what you can to maintain a strong credit score. By understanding the factors that hurt and help your credit score, you can gain a stronger understanding of how lenders view your credit risk and, ultimately, how you can improve your score. These are three important factors that go into calculating an average credit rating (of course, scores are different depending on the individual).
Obviously, payment history plays a primary role in what your credit score is. Lenders want to know what your track record is in other lending situations. This factor makes up the largest portion of how your credit score is determined. Lenders want to know that you have a strong history of responsible financial payments. Your score is determined by whether you have paid past accounts in a timely manner (either on time or before the due date). Now, while history does play one of the most important roles in your scoring, a few late payments can be outweighed by other factors. Likewise, late payments have less impact over time. So, if you slip off your payment responsibilities when you’re young, you are able to dig yourself out of the hole.
Another aspect considered when determining credit scoring is how much debt you actually have. This is where the scoring process can get a little vague for an outsider. Just how much debt is too much? There are some incidents where having a very small balance without missing payments can demonstrate that you’ve managed credit responsibly. This can actually be better for your credit score than not having any balance at all. While it’s important that you don’t have too many opened accounts, having more than one account can be good. This way when you are spending, you’re not using up the account’s entire available credit limit. However, if you owe a lot of money on several different accounts, your score will likely be negatively affected. Lenders see this as a sign that you may be overextended and more likely to make late payments or no payments at all.
Interestingly, the actual types of credit that you take out can make a difference with your scoring. A healthy score reflects a healthy mix of credit cards, retail accounts, installment loans, mortgage loans, etc.. While what FICO and lenders consider a “healthy mix” of credit can improve or score, this doesn’t meant that having one of each type of credit is necessary. In many cases, retail credit cards can actually draw some red flags for lenders. As an overarching guideline, you should only apply for and carry credit that you really need and use. Don’t open any retail credit cards or rewards cards, if you’re not going to use them. Even just carrying an active but unused account can reflect negatively.