By Randy Sacilotto
When it comes to your credit score, remember: You’re in control!
Whether you’re looking to rent an apartment, buy a house, lease a car, open a new line of credit or anything in between, your credit score is going to play an important role along your financial journey. That’s why it’s so important to understand exactly how your credit score is calculated and what you can do to improve (and maintain) your number.
At its most basic level, your credit score is a three-digit number that represents your long-term history of borrowing money and paying it back. Most people understand the general idea: Responsible financial habits – actions like paying at least your monthly minimums on time and never missing a payment – lead to higher scores, while less responsible actions – say, maxing out a credit card or letting an outstanding bill go to collections – lead to lower scores.
A good credit score can serve as a proverbial skeleton key along your financial journey, providing access to favorable interest rates and other opportunities that help you responsibly achieve your fiscal goals. A poor score, on the other hand, can be an obstacle that forces people to put off big decisions or settle for high interest rates on new debt.
Thinking about your credit score can be stressful. But it doesn’t have to be. It’s important to remember that this three-digit number isn’t a mysterious, random calculation; it’s a representation of your own financial behavior. In other words, you’re in control! Once you have an understanding of how it’s created, you’ll see that you can make active decisions that can go a long way toward boosting, maintaining or repairing your credit score.
So… how are credit scores calculated?
Credit scores are calculated based on a combination of data included in your credit report. The final number will vary depending on what you are applying for. Many lenders, financial institutions and other credit agencies use their own proprietary algorithms for calculating credit scores, meaning that every individual person can accumulate dozens of different credit scores over time.
The most widely used metric, however, is the FICO score. FICO calculates your final credit score by looking at the following five specific categories of your financial situation:
- Payment history: Worth 35 percent of your total score, this is the most heavily weighted category in FICO’s credit score calculation
- Amounts owed: This category includes all of your existing debt, from credit cards to mortgages to automobile loans. It is worth 30 percent of your total score.
- Length of credit history: The amount of time in which you’ve been an active credit user makes up 15 percent of your FICO score. Parents or guardians will often open low-limit credit cards in their children’s names in an effort to give them a head start to building this category.
- New credit inquiries: Worth 10 percent of your total score, this category tracks how often you’re applying for new lines of credit. You won’t necessarily get dinged for every application (after all, your score also depends on building a steady history of use!), but it is wise to leave some buffer time between inquiries and avoid signing up for all of those “special offers” you’re receiving in the mail.
- Mix of credit: Also worth 10 percent of your total score, this category looks for diversity in your credit portfolio.
Knowing the ingredients that go into your credit score will help you develop a long-term financial strategy to build your credit and set yourself up for the future.
So… what are the first steps?
The best answer to this question is very simple: Develop and maintain responsible habits.
- Avoid missing monthly payments: Set monthly reminders on all of your due dates, or – better yet – enroll in automatic payment plans.
- Keep an eye on your credit limits: In an ideal world, we’d all be able to pay off 100 percent of our debt at the end of every month. But we understand that isn’t a realistic situation for many people. That said, if you need to carry month-to-month debt, experts recommend keeping the amount of debt you carry under 30 percent of your total credit limit.
- Start early: If financially possible, start building your credit history at an early age. Obviously, we wouldn’t recommend going on a spending spree with your first line of credit – but charging one piece of your monthly budget (say, gas or groceries) and getting into the habit of immediately paying it off could go a long way in establishing a strong credit history.
Of course, we understand that everyone’s financial situation is different and that unexpected expenses or life events can quickly uproot your well-planned strategy. That’s why it’s important to remember that your credit score isn’t permanent. If your current score isn’t as high as you’d like it to be, there are proactive steps you can take immediately to start moving in the right direction.
If you want to start taking action to improve your credit score, Navigant Credit Union can help. You can learn more about credit scores, credit reports and several other money management topics by visiting Navigant Credit Union’s online Financial Wellness Center.