Before we begin, what IS a credit score? Your credit score is a set of calculations used to determine your credit worthiness to lenders ranging from about 300 to 850 points. Equifax, Experian, and Transunion, the three major bureaus, each calculate your score a little differently, but follow the same basic categories. In their calculations, they’re going to look at your payment history, credit capacity, credit history, mix of credit, and new credit. Below, we’re going to discuss each factor.
Simply put, do you pay your bills on time? Payment history is one of the largest and most important portions of your credit score calculation. Missing payments, even just one, can drastically reduce your credit score. Additionally, if an account is charged off or turned over to collections, your score will suffer. When working with your credit score, one of the most important things you can do is pay on-time.
Your credit capacity is calculated by looking at how much debt you owe compared to how much credit is available to you. Ideally, you want to keep your statement balance on credit cards at or below 20%. For example: If you have a $1,000 credit limit, you should try to avoid carrying a balance higher than $200 on that card. When you carry balances close to your credit limits, you’re deemed a higher risk and your score is reduced to reflect that risk.
How long have you had your accounts and made payments? While establishing a strong credit history will take time, it’s important to note that closed accounts will eventually be removed from your credit report and you’ll lose some credit history as a result. In essence, the longer you’ve held an account open and maintained a good standing with that account, the better it will look on your report.
Mix of Credit
The bureaus will also be looking at the different types of credit in your name for this calculation. Ideally, you’ll want to have a combination of installment loans such as personal or vehicle loans as well as revolving loans such as credit cards.
Your score will also take new credit into consideration. It’s not as heavily weighted as your payment history or credit capacity, but it’s still important to apply for new credit and maintain a good standing with the new account(s). As your older accounts that have been paid off and closed begin to drop off of your report, it may be a good idea to finance a new project or purchase you have planned to maintain your score. Keep in mind, however, too many inquiries and new accounts will adversely impact your score.
In summation, the best things you can do to build, establish, and even repair credit are the following:
- Make your payments on-time and avoid late payments, even if you’re only making minimum payments;
- Keep your balances on credit cards and other revolving accounts low;
- Maintain a strong credit history by keeping accounts such as your credit cards open with good standings; and
- Finally, carry a blend of installment and credit card accounts and apply for new accounts sparingly.
You may be asking yourself “Why should I care about my credit score?” In truth, your credit score has a number of uses. Primarily, your score will determine the interest rate you’ll have on virtually every loan or credit card you apply for and open which will determine how much extra you’ll have to pay on that loan.
As an example, let’s use a $20,000 auto loan being financed over 5 years and assuming the borrower is making only minimum payments. Below, we’ve included a chart to compare differences your score can make, using some example rates (rates will vary by institution and product).
|Score||Rate||Min. Payment||Total Cost||Total Interest|
As you can see, the difference in interest paid between Excellent and Poor over the 5 year loan is staggering. A borrower with a Poor score could have saved almost $7,000 simply by maintaining a higher credit score. This example only looks at a 5 year loan, imagine what the difference in a 30 year mortgage would look like!
At Credit Union of Ohio, we offer free financial counseling to our members to help build, establish, or repair your credit score. Visit cuofohio.org for more information, to open a membership, or schedule an appointment with one of our financial counselors.