Credit Score Factors Pie – Lesson #2
We love the saying “It’s all about the pie”. Not this pie. Rather, it’s about the Credit Score Pie.
Credit Score Factors
Once people get their credit scores — and if you haven’t done this already you should – anyway, once they get their credit scores, they tend to look at their credit report and see that they may have a couple of items flagged for impacting their credit score. The gut reaction is to treat these all equally. Or, worse, focus on the easiest item. That’s a mistake.
The most commonly used credit score, the FICO score, is made up of 5 credit factors. Here are the 5 pieces and the percentage of the score each piece accounts for.
Payment History – 35%
Amounts Owed – 30%
Length of Credit – 15%
Credit Inquiries – 10%
Mix of Credit – 10%
The irony is that it’s really not all about the credit score pie, it’s mostly about the biggest pieces.
Payment History and Amounts Owed. These are the biggest credit score factors and nobody has a great credit score if these are out of sync. That’s because they represent nearly 2/3rds of your credit score.
Payment history is critical and as the name suggests time is your best ally to impacting this area. The key lesson is that a late payment in the recent past hurts more than one a few years ago. In fact, all your history is wiped clean after 7 years, unless you had a bankruptcy and then it’s 10 years. Net, net, if you aren’t paying on time, you have to figure out how to do this now. You can’t be late and still have a good score. Being late on payments a month before you hope to get a major loan is a no-no.
Amounts owed are all about Credit Utilization. What? A fancy term for the ratio of what you can charge – your credit limit – to what you do charge – how much of that credit limit you use. Let’s look at an example; Jack and Jill have the same credit limit on their cards, yet Jill uses her card less so she has a 25% ratio. It turns out that risk experts say people who use more of their limits are more risky. While many sources say a credit utilization ratio of 40% is fine. Someone with a 775 and higher scores tend to have about card utilization ratios in the 10% range. In short, don’t overuse your credit cards.
Mix of Credit. This wedge says that people with installment credit and revolving credit tend to be less risky than people with just one or the other and thus have higher credit scores. Installment credit examples are auto, home and personal loans. The most common revolving credit is credit cards.
Length of Credit. When it comes to length of credit just start early and stay on it. You can’t change time. If you are young, you want to start developing good habits now, so when you are ready to make a major purchase you have a few years of good credit history. Don’t cancel any credit cards with long credit histories.
There are 2 types of inquiries: Soft and Hard Inquiries. A soft inquiry is whenever you, for example, check your own credit score, or pull a credit report on your own. Soft inquiries are non-score impacting because they are not requests for new credit. Hard inquiries are requests for new credit. An example of a hard inquiry is applying for credit like getting a cell phone, or a credit card. So why do hard inquiries ding your score? It turns out that people who request credit more frequently are more risky, so the credit score reflects this.
Our experience is that most people love to focus on credit inquiries. While they shouldn’t be ignored, it’s only 10% of your score. When it comes to credit inquiries, timing is more the issue, don’t apply for credit at the same time when applying for a loan.
Also, don’t let credit inquiry fear stop you from shopping around for a loan, in most cases all credit inquiries in a 30 day window are considered as just 1 inquiry, and the industry to trying to move this to 45 days in the future. Note: this is true for home loans, but not for car loans and personal loans, so be cautious.
In summary, spend most of your effort around the biggest two credit score factors: Payment History and Amounts Owed, by paying on time and keeping your balances low.