Oh those three little numbers, 572, 647,756. What do they really mean and why are lenders so concerned about them? Why should you be concerned?
Well the FICO scoring model (Fair Isaac Company developed the software that determines the score, thus FICO) and virtually all of the lenders and creditors adopted the system about 14 years ago. The problem is they didn't tell you that they were going to do this and they also didn't tell you what it means and how to get and keep a score well into the 700 range.
With the FICO scoring system the scores range from 350 on the low end to 850 on the high end. Today only about 1 in 1400 people has a score over 800. Conversely about 1 in 7 have a score under has a score under 600. The average for the US is around 660. So half have a score higher and half have a score lower.
First let me say this, the credit scoring system is a voluntary system that the creditors contribute information at their discretion. There is NO LAW that requires them to list your information, good or bad. The credit bureaus are companies in the business to make a profit for their investors, just like any other company, they are not and never have been a government agency. And you have never asked to participate in this system. But you are anyway. There is no law that says any of your information needs to be reported for 7 years, 7 months, 7 days or even 7 minutes. This is just a rule that the bureau's and creditors came up with for their system. Also, did you ever notice that they are in a big hurry to get the bad stuff on your report, but it seems that they are never concerned with correcting it to make it right?
Anyway, the FICO scoring system is broken down into five factors that control your score. It looks like this:
- 35% payment history. I think everyone knows this one. Pay your bills on time. If a reported account is over 30 days late it will get reported and it will lower your score. If your bill is paid 18 days late you will probably have a late fee to pay as well but it will not be listed as late. It needs to be 30 days or more late. After that is 60 days, 90 days and finally collection or charge off. A 60 or 90 day late on your report is worse than a 30 day late.
- 30% of your score is the balance in relationship to your high credit limit on revolving accounts (credit cards). The higher your balance versus your credit limit, the lower your score will go. Ideally you should have little to no balance on your revolving debt but use them for minor purchases each month and pay them off. The bureau is looking for activity on these cards and you need to use them occasionally to keep them active. Revolving accounts also includes accounts that you may not receive a credit card for. Locally "Les Schwab tires" offers credit for wheels and tires. They do not issue a credit card but rather store credit. This is listed on your report as a revolving account so be aware of these kinds of accounts. 3 to 5 revolving accounts are optimum for maintaining high scores. More about credit strategy in another article.
- 15% of your score is your credit history. This is the length of time you have had credit established. This is why someone in their early to mid 20's compared to someone in their 40's with the same amount of credit cards, car loan and mortgage can have substantially different scores. It would be the length of time they have had credit established.
- 10% is the mix of credit. The scoring model considers a mortgage, an installment loan and three to five credit cards to be the optimal mix.
- And last 10% is inquiries. This is where creditors pull your credit report for the purpose of granting credit. Any damage to a credit report this may cause is only going to affect your score for no more than 12 months. Depending on the depth of your report (the other above items) inquiries can have a little or a lot of impact. But for no more than 12 months. If your score is low, usually this is not the reason.
That's it. Those are basically the only things that control your score. Understand and control those and you can beat the system.
With that said, there is a time weight that is considered as well. First of all, your recent history has the biggest impact on your score. If you were 30 and 60 days late on your car loan a couple of months ago, your score will be lower because of that. But if you were late on that loan three years ago, it will have virtually no affect on your score today as long as you have made your payments on time since then, The FICO model primarily looks at the last 24 months to determine the likelihood of you making payments on time in the next 24 months. So the older the problem, the less impact it has on your score. More about credit strategy in other articles.
It is critical that you understand these five factors before you decide to employ any strategy to raise your scores or before you do something to destroy your score. This is why many of us who coach clients about their credit score suggest that they never close a revolving account. If you do, you lose the history and a paid account that is easy to control. Remember the lower the balance from the credit limit and the longer you have had the account, the higher the score.
Coming up we'll explore credit score strategy based on these five factors and show you how to maintain scores in the 700 range or how to increase low scores and keep them in the 700 range, regardless of your credit history.