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.

Once people get their scores — and if you haven’t done this already you should - anyway, once they get their scores they tend to look at their report and see that they may have a couple of items flagged for impacting their 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 areas. Here are the 5 pieces and the % 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 pie; it’s mostly about the biggest pieces.

Payment History and Amounts Owed are the biggest chunks and no one has a great score if these are out of sync. That’s because they represent nearly 2/3rds of your 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 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 20% range. In summary, don’t overuse your credit cards.

Mix of credit says that people with installment credit and revolving credit tend to be less risky than people with just one or the other. Installment credit examples are auto or car loans. The most common revolving credit is credit cards.

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.

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 they ding your score? Well it turns out that people who request more frequently are more risky, so the score reflects this.

Our experience is that most people love to focus on inquiries. While they shouldn’t be ignored, it’s only 10% of your score. When it comes to inquiries, timing is more the issue, don’t apply for credit at the same time when applying for a loan.

Also, don’t let inquiry fear stop you from shopping around for a loan, in most cases all inquiries in a 30 day window are considered just 1 inquiry, and the industry to trying to move this to 45 days in the future.

Ok, we covered quite a bit. In summary, spend most of your effort around the big two wedges, Payment History and Amounts Owed, by paying on time and keeping your balances low.

The next lesson will cover where to get each one of your credit scores if you haven’t done so already.