We all worry about our credit scores. Perhaps you check your credit score, periodically through Experian or downloaded the Credit Karma app onto your phone. We make sure we pay our bills on time and pay more than the minimum amount due on our credit cards. But, what do the various credit scores actually mean? And, what are the various factors that determine your credit score? How can we ensure that we have good credit scores?
Unlike Golf, You Want a High Score
Yes, your credit score really does matter. When applying for any type of loan, whether it be student, business, car or home, your credit score is going to not only factor into whether or not you are approved for the loan, but what your interest rate is. Don’t let what appears to only be a few percentage points fool you: the differences in interest rates could mean a difference of thousands of dollars. Would you rather be using that money to pay off your loan, or use it to take a vacation, grow your business or invest in your retirement? We’re guessing the latter! Your credit score affects more than just which loans you qualify for, but your ability to rent an apartment or obtain the cell phone service you want. If you don’t want to have to pay a deposit to get your cable or electricity turned on, then you will want to ensure that you have a good credit score.
Paying all of your bills on time and paying more than just the minimum amount due is certainly necessary in your quest to have a good credit score, but there are actually other factors that play a part in your credit score. You will also want to watch out for any derogatory marks on your credit report. Derogatory marks include any civil judgements against you, tax liens and past bankruptcy. So, if you are having a scuffle with your neighbor over a tree that is being taken to court or you forgot to pay that speeding ticket from a previous vacation, you will want to get those issues resolved so they may be cleared from your credit report.
Yes, having several open accounts (credit cards, loans) can be beneficial to your credit score, as it demonstrates to potential lenders that you are trusted with credit and can use it, responsibly. And, yes, you will want to actually use those credit cards to pay bills or make purchases, as credit cards that are not being used are subject to having the account closed by the lender, which can also have a negative impact on your credit score. However, you will want to be careful that you are not racking up too much credit card debt, as your credit card utilization is another factor that determines your credit score. Ideally, you should try to keep your credit card utilization below 30% of your total available credit available.
Now, before you get excited and run out to apply for a bunch of new credit cards to show a potential lender that you are trusted with various types of credit (and, boost your credit score), take into consideration that lenders will run your credit report as part of their decision-making process; every time your credit report is run, it lowers your credit score. As such, don’t run out and apply for, or open, a bunch of new accounts all at once, as that may actually have an adverse effect on your credit rating. Fortunately, you can check your own credit score using such apps as Credit Karma, without it affecting your score, which is important if you are preparing to apply for a small business loan. The various ages of your accounts plays a role, too, which is yet another reason as to why opening a bunch of new accounts isn’t going to necessarily do you any favors. The longer you have had your accounts open and in good standing, the better for your credit score.
As you can see, there are several things that can factor into determining your credit score, which in turn can determine whether or not you qualify for a loan. To summarize, things to keep an eye on:
- Payment history for accounts such as loans and credit cards
- Credit utilization
- Type, number and age of accounts
- Total debt
- Public records, such as liens and civil judgements
- Number of new accounts recently opened
- Number of inquiries for your credit report
Yes, there are certainly a lot of things that factor into your credit score. However, there are also any number of things that you may think would affect your credit score that actually do not. Some examples are:
- Marital Status
- Where You Live
- Salary or Occupation
The Big Three
The three credit agencies from which potential lenders can pull your credit score are Equifax, Experian and TransUnion. While each agency may generate a slightly different number, all three should provide a similar picture of your credit history, with a score anywhere between 300 and 850. (Again, the higher the better.) The breakdown of how these agencies determine your credit score are:
- Payment History – 35%. Pay your bills on time. If you have to be a bit late, the later you are in paying the worse it is for your credit score.
- Amounts Owed – 30%. How much of your total available credit have you used? The less the better. Additionally, this is where having too many loans on which you are still paying can have a negative impact on your credit score. Consider consolidating any loans to bring down both the total amount due and your monthly payments.
- Length of Credit History – 15%. Again, opening up a bunch of new accounts at once isn’t really going to do your credit score any favors. Lenders want to see that you have a solid history of being able to use credit responsibly. However, a short history is fine, provided you have been making your payments on time and keeping your credit card utilization down.
- New Credit – 10%. Many lenders see someone with a bunch of new accounts as a risk, because it is usually indicative of someone who is having cash flow problems and is opening new credit to cover expenses.
- Types of Credit in Use – 10%. Lastly, your credit score is determined by the types of accounts you have. As this is a relatively small determining factor, don’t stress too much if your only account are of one type. However, it is helpful if you have a balance of credit cards, loans (student, car, mortgage) and store accounts. This will demonstrate to lenders that various types of creditors have deemed you responsible and trustworthy.
When preparing to apply for a loan, start keeping an eye on your credit score about 6 months before you plan on applying. This will give you time to dispute anything with which you do not agree, or resolve any outstanding issues. Additionally, it will allow you time to address any potential credit card fraud, should there be account open under your name that were not actually opened by you.
Don’t despair if your credit is less-than-stellar. By looking ahead and giving yourself time to prepare for an upcoming loan application, you are giving yourself time to start making better choices regarding your credit. It may mean that you have to start cutting back on the dining out or tickets to the opera for a while, to ensure that you can bring down your credit card utilization and pay down those student loans, but it will be worth it in the long run, when you are easily able to obtain your small business loan and follow your dream of being an entrepreneur.