Our credit score reflects how likely we are to repay debt. Having a good score can open a lot of doors when we need financing. It increases our chance of credit card and loan approval, qualifies us for better interest rates and lower security deposits, give us more negotiating power, and so much more.
Some employers will even run a credit report to see how responsible you are with money!
We all desire to achieve and maintain exceptional credit, but in order to do that, we need to first understand the 5 elements that make up our credit score and what affects it the most.
1. Payment History (35%) – Lenders want to be confident in your ability to make timely payments. Your history helps them asses the risk they’re undertaking if they choose to extend credit to you.
2. Amounts Owed (30%) – This does not refer to the total debt you carry, but rather your credit utilization. If you owe $100 and your credit limit is $1,000, your credit utilization ratio is 10%. Ideally, this number should stay below 30% because higher ratios historically indicate a higher risk of default.
3. Length of Credit History (15%) – This can be broken down into several parts: how long each account has been open, how long specific types of accounts have been open, and how long since accounts have been used. The older your credit history, the better. You may be tempted to cancel that old credit card you’ve finally paid off, but if it has the longest history of payment, consider keeping it open. Just don’t use it!
4. Credit Mix (10%) – Having a diversified credit portfolio demonstrates your ability to handle various types of credit including credit cards, student loans, mortgages, retail accounts, etc. Your credit mix influences only 10% of your score; so, it should not be a motivating factor to open accounts that you don’t need.
5. New Credit (10%) – Opening up too many accounts in a short time can be a red flag for lenders. This behavior could indicate that you constantly need access to credit and may have trouble making future payments.
THE BOTTOM LINE:
It would be ideal to have enough money to pay everything in cash without ever borrowing money, but that just isn’t realistic for most people. Therefore, it is important to establish and maintain a good credit score for the times when we can’t pay up front, such as when we purchase a car or home. It can even make or break a job opportunity!
Your credit score can be an important tool in helping you achieve your financial goals; so, don’t underestimate the three-digit number. It can affect your life in many ways.