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.

Credit Score Definition 101 – Lesson #1

New to Credit Scores? Watch this short overview. In less than 3 minutes, this video will provide you the basics of credit scores.

Companies use a credit score to assess your likelihood of paying whether its to get a car loan, a home loan, a credit card, or even a cell phone.

Credit Score Definition

A quick Google search discovered nearly 20 definitions for “credit score” which highlights how confusing this can get.

To quote myFICO “This term is often used to refer to credit bureau risk scores. It broadly refers to a number generated by a statistical model which is used to objectively evaluate information that pertains to making a credit decision.” Yikes!! Okay, take a deep breath and let’s simplify this.

This credit score isn’t one score at all, it’s 3 credit scores. Why? Because there are 3 companies that collect data on your credit history and create reports. Plus, you may hear the terms “FICO Score” and “Credit Score” used interchangeably. This is sort of analogous to Band Aid and Bandages. Band Aids aren’t the only bandages, but they probably are the ones most people recognize and the same holds for the FICO brand as FICO is the most used credit scoring system.

Next you might guess the score range is 1-100. Nope. Generally it’s a 3-digit number and the FICO system goes from 300-850.

So is it like an SAT score? Yes and No. Yes in that it’s really important. But, your SAT score is set in stone once you’ve taken the SAT. Your credit score changes over time, more like your cholesterol score. Both change as your behavior/habits change!

So how does this impact our lives? Besides the fed rate, this is going to be one of the greatest determinations of your loan payments. At the time of this recording the best rate for a 30 yr mortgage is 5.45%. But the worst rate is over 10%. Today, the best rate can mean $1000/mth LESS in payments for a $300K house. Check out the chart on myfico.com to see what this means for your house or car. One thing is certain, the price of credit score/report products often pay for themselves.

You can increase or decrease your scores through your behavior. But, we are going to focus on upward movement. So, what’s a good credit score? The banks are awarding the best rates to people with a FICO over 760. But wait, if you have 3 scores which one has to be a 760? Well many home loan lenders seem to take the middle score. So if your scores are 710, 720 and 760, they will likely use the mid score to calculate your rate. Most car loan lenders just use one score, but it makes sense to know all three as different lenders use different data sets for their scores.

If you’ve never seen your three scores, that’s the first step, just click on Score Watch ad next to this screen to get started.

In order to start figuring out how to manage your scores, you’ll need to understand what goes into your scores.

There are 5 key areas that impact your score. I’ll cover these in the next lesson #2 – the credit score factors pie.

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