In order to understand whether or not you have good or bad credit you must first know your FICO score. FICO score is the technical term for credit score. The term itself is an acronym for the company that creates all FICO scores: Fair Isaac Corporation. The FICO score is a credit rating system ranging between 300 and 850. 300 is the lowest score and 850 is the highest. In order to have “good” credit, you want your score to be over 700. “Perfect” credit ranges between 760 and 850.
This three digit FICO number is basically a percentage breakdown of your entire credit history taking into account the following five factors:
- 1) Payment History 35%
- 2) Amount of Debt Owed 30%
- 3) Length of Credit History 15%
- 4) Types of Credit in Use 10%
- 5) New Credit and Inquiries 10%
Even though length of credit history only accounts for 15% of your FICO score, it establishes the most important factor of credit itself. You must have at least one line of credit to establish a credit history. Once you’ve opened your line of credit by signing up for that first credit card, the remaining four factors can be examined further.
Payment history accounts for the highest percentage of your FICO score. This portion of your score focuses on how often you pay your bill on time and how severe any late payments are, if they exist. In order to be in the very top of this category, it is optimal to have no late payments. However, the hit your score takes from a late payment depends upon how long ago the late payment occurred as well as how late the payment was. If the late payment happened last month, your score will take a bigger hit than if the late payment occurred two years prior. Also, your score will be affected more harshly by a 90 day late payment than it will be by a 60 day late payment. However, prompt payments alone will not guarantee a good credit score.
The FICO score also takes into account the amount of debt owed. Basically, this factor examines the amount of debt owed in relation to the total line of credit for any given account. If a high percentage of the total credit amount is owed, it can indicate a financial overextension and will reflect poorly on your score. For example: Owing $8,500 on a $10,000 dollar limit of revolving credit. However, paying this debt down over a period of time can bump up your score a great deal. In order to maximize your score, along with regular payments, you should only use up to 30% of your available credit. Debt owed also encompasses any type installment loan and what percentage is still outstanding versus what has been paid down.
A small percentage of your score is based on the different types of credit in use. Types of credit range from credit cards and retail accounts, to mortgage and installment loans as well as financial company accounts. This portion of your score examines the ability to handle multiple financial obligations in a responsible manner. It’s not a major factor, but will play a larger role the less information there is in your overall report.
Applying for new credit initiates a credit inquiry. This will happen if you sign up for a new card or apply for a loan. Too many non-personal credit inquiries can damage your overall score. However, FICO will distinguish between different types of new accounts as well as how many of your current accounts are actually new. FICO also does a good job at distinguishing between rate shopping for a loan or mortgage and opening new and frivolous credit lines.
A good credit score can go a long way towards making many aspects of your life easier. It will assist you in a range of situations from securing a home loan and lowering interest rates to leasing a car and even landing a new job. Understanding your credit score is crucial to building a strong credit history and a bright future. Throughout your life, without a doubt, when it comes to your personal finances, the question you will most often hear is: How’s your credit?