What Determines Your Credit Score by Credit Virgin
Now, it’s finally time take a look at what actually affects John’s credit score. We’ll use this pie chart to help explain exactly what affects his credit score and how each segment is weighted in to the overall equation. First we’ll look at payment history. John’s payment history accounts for 35% of his overall credit score. This is by far the largest percentage. Payment history takes into account whether or not John pays his bills on time. This includes payment on things like credit cards, mortgages, car loans, or other installment loans. When John pays his bills on time it makes his lenders happy, but when he is late on a payment it makes his lenders mad and his late payment gets reported on his credit history which makes his credit score go down. John’s payment history also takes into consideration the number of credit cards and loans John has. In general the more accounts he has paid on time better because it shows that he is more reliable.
Next we’ll look at credit utilization. Credit utilization accounts for 30% of your credit score. Credit Utilization takes into account your debt to limit ratio, and your credit mix which is the different types of credit on your credit history. There are two major segments; one is revolving credit, which is a type of credit that doesn’t have a fixed number of payments. This segment mainly refers to credit cards. The second segment is installment loans which are loans with a fix number of payments such as a home mortgage or a car loan. To build a really strong credit score, the credit card companies want to see a mix of revolving credit and installment loans, but for now we’ll focus only on revolving credit because most students aren’t buying cars and houses while they are in school. Now we’ll take a closer look at how your credit utilization score is calculated when it comes to revolving credit.
To score well in this category you need to have a relatively low debt to limit ratio. A debt to limit ratio takes into account your outstanding debt or the money you owe, compared to your credit limit this is how much you’re allowed to spend on your credit card.
Let’s look at this in more detail. We’ll pretend John has just received his first student credit card. The card has $400 credit line which is represented by the empty bar. A credit line is the amount he can spend on his credit card without getting trouble from the credit card company. If he exceeds his credit line, he will have to pay penalty fee. So with this card John is allowed to spend $400 dollars without having to pay a penalty, but his is very deceiving because although John is “technically” allowed to spend $400, but he shouldn’t because spending anymore than 50% of your credit line can actually hurt his credit score. So John should never have more than $200 of debt on this credit card because his debt to limit ratio will be over 50%. So John can spend anything up to $200 without hurting his credit score but after he spends more than $200 his credit score will begin to suffer, and if he spends more than $400 he will be charge a huge penalty fee! The most important thing to remember about credit utilization is to manage your spending on your credit card and never go about a 50% debt to limit ratio.
The next largest component is length of credit history. Length of credit history makes up 15% of John’s credit score. Yea this is always a big bummer for college students like John. Unfortunately, there’s nothing he can do to increase the length of his credit history. That’s why it’s super important that John starts build credit as soon as possible! If he waits he can never get this time back. Length of credit history specifically takes into account how long you’ve had a credit card and the frequency with which you use your account. Lenders will be more likely to lend John money if they see that he has been actively paying off his credit card bills. To be successful in this category he needs to get a credit card as soon as possible in order to increase the length of his credit history and then make at least one small purchase per month on his card. So he can show lenders a history of paying his bills on time.
The next section is new credit. New credit accounts for 10% of John’s overall credit score. New credit includes new revolving lines of credit, and new installment loans. The credit card companies don’t want to see John rushing out to get multiple new lines of credit at the same time. This makes him look extremely risky to the credit card company, because it looks like he’s running out of money so he needs to take out multiple loans to pay for a bunch of different things.
The new credit segment also takes into account recent credit inquiries. A credit inquire is when someone checks your credit score. Anytime you apply for a new line of credit the lender will look at your credit score to determine how reliable you are. If you apply for multiple lines of credit there will be many companies looking at your credit report.
Anytime someone looks at your credit report, it shows up on your credit history. If a company sees that a lot of other people have been looking at your credit report. They view this negatively because I looks like you are seeking loans from a lot of different companies, which tells them you are in desperate need of money. In conclusion the worst possible thing you could do as a college student without credit would be to go out and apply for a bunch of different credit cards at the same time.
When applying for your first credit card you should only apply for one card at a time. Also, you don’t want to get a second credit card within six months of getting your first because it takes six months for your credit history to start showing up on Fico score. If you get multiple credit cards around the same time credit card companies will think you are desperate for money and view you as a risk.
The last factor that is taken into account when determining your credit score is different types of credit on your credit history. Types of Credit account for 10% of your credit score. Once again there are two major types of credit, revolving Credit and installment loans. Lenders will want to see how many accounts you have open and what category each account falls into. Once again they really want to see a mix between revolving credit and installment loans. However, you don’t need to run out and buy a car or house just to have an installment loan show up on your credit history. Get a credit card to start building a good history on your revolving credit. Then, make big purchases with loan installments when necessary AND when you have the money.
Hopefully now you have a good idea of how your credit score is calculated and how you can build a good credit score. In the next video we’ll help to dispel popular myths about what builds your credit.