Your credit score is one of the most important numbers in your life, and it is absolutely critical in managing your personal finances. Throughout your adult life, you will see this number influence major financial decisions. Five factors are used to determine your credit score.
Payment history accounts for the largest portion of your credit score, at 35 percent. This is your track record on paying your credit card or loan bills in a timely manner: whether you've paid on time, were late even just once or were sent to collections. You do not have to pay your balance in full every month on most credit cards; credit card companies allow you to have a minimum payment for your convenience. You must pay at least the minimum amount listed on your bill to avoid a negative effect on your credit score.
Debt-to-Credit Limit Ratio
Your debt-to-credit limit ratio makes up 30 percent of your credit score. This is the percentage of money you have already borrowed compared with the amount you are allowed to borrow, i.e. your credit limit. Keeping this ratio below a 1 helps to raise your credit limit, which reduces your ratio even more.
15 percent of your score is determined by the length of your credit history, which began the day you opened your first credit card. The longer a history you have, the better. Do not cancel your oldest credit card if you can avoid it; it will erase a large chunk of your credit history and negatively affect your credit score.
10 percent of your score is affected by the types of credit you have in your history. A mix of credit cards, mortgages, car loans, etc. shows you are able to handle your fiscal responsibilities well. That is, of course, if you have a good payment history. But do not apply for loans and credit cards just to have a good mix because new account inquiries deduct points from your score.
New Account Inquiries
Account inquiries determine 10 percent of your credit score, whether the inquiries were made when you applied for credit or opened any new accounts recently. Constantly searching for or opening new credit will make banks less likely to invest in you because you are seen as a risk. It looks to them as if you are finding new ways to spend money without repaying it. However, if you are shopping around for the best interest rates on loans, as long as the account inquiries are within a two-week span, your credit score will not be affected with each inquiry as long as the inquiries were for the same kind of credit, e.g. three inquiries for a car loan within two weeks. The credit bureaus understand your right to shop around for the best options.
- "The Money Book for the Young, Fabulous and Broke"; Suze Orman; 2007
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