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 worried?
Well, the FICO scoring model (Fair Isaac Company developed the software that determines the score, hence FICO) and virtually all lenders and creditors adopted the system about 14 years ago. The problem is that they didn’t tell you they were going to do this and they didn’t tell you what it means and how to get and keep a score in the 700 range.
With the FICO scoring system, scores range from 350 at the low end to 850 at the high end. Today, only 1 in 1,400 people have a score above 800. By contrast, about 1 in 7 have a score below 600. The average for the US is around 660. So, the half have a higher score and the other half have a lower score.
First let me say this, the credit scoring system is a voluntary system where creditors contribute information at their discretion. THERE IS NO LAW that requires them to list your information, good or bad. Credit bureaus are companies in business to make profits for their investors, like any other company, they are not and have never been a government agency. And you have never asked to participate in this system. But you are anyway. There is no law that says your information must be reported for 7 years, 7 months, 7 days, or even 7 minutes. This is just a rule that the bureau and the creditors came up with for their system. Also, have you ever noticed that they’re in such a hurry to fix the bad things in your report, but never seem to bother to fix it to make it right?
However, the FICO scoring system is broken down into five factors that control your score. Does it look like this:
- 35% payment history. I think everyone knows this one. Pay your bills on time. If a reported account is more than 30 days past due, it will be reported and your score will be lowered. If your bill is paid 18 days late, you may also have to pay a late fee, but it won’t show up as late. It has to be 30 days or later. After that it’s 60 days, 90 days and finally the charge or cancellation. A 60 or 90 day delay on your report is worse than a 30 day delay.
- 30% of your score is the balance in relation to your high credit limit on revolving accounts (credit cards). The higher your balance compared to your credit limit, the lower your score. Ideally, you should have little or no balance on your revolving debt, but use it for minor purchases each month and pay it off in full. The office is looking for activity on these cards and needs to use them occasionally to keep them active. Revolving accounts also include accounts for which you cannot receive a credit card. Locally, “Les Schwab Tires” offers credit for wheels and tires. They do not issue a credit card, but rather store credit. This shows up on your report as a revolving account, so be careful with these types of accounts. 3-5 rotating accounts are optimal for keeping scores high. More on credit strategy in another article.
- 15% of your score is your credit history. This is the length of time you have had established credit. This is why someone in their 20s and 20s is compared to someone in their 40s with the same number of credit cards, because loans and mortgages can have substantially different scores. It would be the amount of time they have had established credit.
- 10% is the credit mix. The scoring model considers a mortgage, an installment loan, and three to five credit cards to be the optimal combination.
- And the last 10% wonders. This is where creditors pull your credit report in order to extend credit. Any damage to a credit report this may cause will only affect your score for no more than 12 months. Depending on the depth of your report (the other items above), queries can have little or a lot of impact. But for no more than 12 months. If your score is low, it’s usually not because of that.
That’s it. Those are basically the only things that control your score. Understand and control them and you can beat the system.
That said, it is also considered a weight of time. First of all, your recent history has the biggest impact on your score. If you were 30 and 60 days behind on your car loan a couple of months ago, your score will be lower because of that. But if you fell behind on that loan three years ago, it will have virtually no effect on your current score, as long as you’ve made your payments on time since then. The FICO model primarily looks at the past 24 months to determine the likelihood of you making on-time payments in the next 24 months. So the older the issue, the less impact it has on your score. More on credit strategy in other articles.
It’s critical that you understand these five factors before you decide to employ any strategy to boost your scores or before you do anything to destroy your score. This is why many of us who advise clients on their credit scores suggest that they never close a revolving account. If you do, you lose your history and a paid account that’s easy to monitor. Remember that the lower your credit limit balance and the longer you have the account, the higher your score.
Coming up, we’ll explore credit scoring strategy based on these five factors and show you how to keep scores in the 700 range or how to boost low scores and keep them in the 700 range, regardless of your credit history.
